Commerce Paper IV (English Version)-munotes

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PRODUCTION PLANNING AND
CONTROL
Unit Structure
1.0 Objectives
1.1 Introduction
1.2 Production Management
1.3 Production Planning and Control
1.4 Steps in production planning and control
1.5 Production system
1.6 Productivity
1.7 Summary
1.8 Exercise
1.0 OBJECTIVES
After studying the unit the students will be able to:
 Know the concept of production planning and control.
 Understand the definition and objectives of production planning and
control.
 Study the various steps in production planning and contro l.
 Explain the production system and its types.
 Evaluate the term productivity and the factors influencing
productivity.
1.1 INTRODUCTION
Production is a process of combining various material inputs and
immaterial inputs (plans, know -how) to make somethin g for consumption
(output). It is the act of creating output, a good or service that
has value and contributes to the utility of individuals. Since the primary
purpose of economic activity is to produce utility for individuals, we count
as production durin g a period of all activity that either creates utility
during the period or which increases the ability of the society to create
utility in the future. munotes.in

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2 Production is the center of the entire business organization. Production
planning and control functions look after the complete manufacturing
activity. In the management of any task planning and control are the two
basic and interrelated and managerial functions. Planning is a pre -
operation activity while control is the post -operation function and involves
initiating production comparing it with standard, finding out the variation
if any, and taking necessary corrective measures.
1.2 PRODUCTION MANAGEMENT
1.2.1 Meaning
Production is the first and primary function of management because unless
goods are produc ed, they can not be marketed. Production management
includes planning, organizing, staffing, directing, and controlling the
activities of the production function. It involves taking all the decisions
which are required to be taken for producing goods or se rvices according
to specifications at the right time and costs.
1.2.2 The objective of the Production Management
So the objective of production management is to produce goods and
services of the right quality and quantity at the right time and right
manuf acturing cost.
1. Right quality
Product quality is a relative term. The objective of production
management is to produce goods of the quality which is required by the
customers. The right quality is not necessarily the best.
2. Right Quantity
The quantity of production should be decided after forecasting the demand
for the product. The decision on the size of production should be the right
decision to avoid both excess or deficit production.
3. Right Time
The goods should be produced and supplied when they are r equired by the
customers.
4. Right manufacturing cost
The cost of manufacturing is decided before actually producing the
product. This cost can be considered as a standard or pre -established cost.
An attempt should be made to produce the product at this stan dard cost.
1.2.3 Scope of production management
The scope of production management involves taking various decisions
related to the production activities. These decisions are of two types.
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Production Planning and
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3 A. Strategic decisions
These decisions are taken for deciding th e product and production system
and time taken for Production.
The strategic level decisions are
1) New Product Identification and Design
Constant changes take place in consumer likes & dislikes tastes,
expectations. The organization may require introduc ing a new product or
innovating or modernizing the existing one to meet the changing needs
and demands of the consumers so identifying and designing the new
product is the strategic decision of production management.
2) Process Design / Layout and Planning
It involves taking decisions as regards the use of the appropriate
technology for conversion of raw materials into products and planning of
the process of production which can include deciding process design,
determining the work stations, and the flow of work.
3) Deciding Locat ion for the production process
Deciding the location for the manufacturing unit is a very crucial one. It is
taken after considering factors like the supply of raw materials, nearness to
market, availability of transportation facili ties, and labor, climatic
conditions, and so on.
4) Design of Material Handling System
Material handling systems should be such as to minimize the cost and time
and labour involved in material handling. The material handling system is
decided after conside ring various factors such as the distance between the
work stations, intensity of flow or traffic and shape and nature of materials
to be handled.
5) Capacity Planning
Deciding the size of production should be done after considering various
factors such as demand forecasting, availability of resources, Government
regulations, economies of large scale, and so on.
B. Operating decisions
These decisions are short -term and are acquired to be taken for a smooth
production process.
The operational level decisions are
1) Production Planning
It relates to taking production -related decisions on day to day basis such as
allocation of work among the workers, repairs, and maintenance of
machinery, fixing quotas and targets for the workers, and so on. munotes.in

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4 2) Production Control
The use of production control techniques aims at finding out whether the
activities are carried out as per the plan. It involves comparing actual
output with the standard output and if the actual output is less than the
standard output, then measures are ta ken to increase the output.
3) The other activities
The other activities include inventory control, repairs, and maintenance
and replacement of machinery, cost reduction and cost control, time and
motion study providing proper working conditions, and so on.
1.3 PRODUCTION PLANNING ANDCONTROL
1.3.1Definitions
According to Alford and Breatty , "production planning and control
comprise the planning, routing, scheduling, dispatching and follow up
functions in the production process so organized that movements o f
material are directed and co -ordinate as to the quantity, quality, time and
place".
Production planning and controlling are concerned with planning and
controlling production activities. The following are the main objectives of
production planning and co ntrol.
1.3.2 Objectives of Production Planning and Control
a) Continuous flow of production
Production planning and control facilitate continuous production as per the
production plan. This is possible as all operations are planned properly and
also well in advance. Since all the machines are put to maximum use,
there is regular production. This helps to provide a regular supply of goods
to the customers.
b) Optimu m utilisation of plant capacity
Proper production planning and control ensure effective uti lization of
plant capacity. All the resources i.e. men, materials, machines, etc. are put
to maximum use. This results in reduced cost and higher returns to the
organization.
c) Estimate of resources
Production planning and control help to estimate requir ed resources.
Production is planned according to the sales forecast. Based on this
forecast proper quantity and quality of resources are decided. Thus, it
avoids excess or shortage of resources.

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5 d) Minimising wastages
Because of the proper inventory of raw materials, there is proper material
handling. This helps in minimizing wastages of raw material. Also
because of effective control, there is the production of quality goods. This
results in minimum rejects. Thus, proper production planning and control
result in minimum wastage.
e) Teamwork
Proper production planning facilitates teamwork among various
departments. The production department works in close cooperation with
other departments such as purchase, marketing, finance, etc.
f) Achieve goals
The objective of production planning and control is to achieve the goals of
the firm quickly. The resources of the organization are scarce so it is
necessary to plan properly as it will facilitate the achievement of goals.
Production goals are generally qualif ied which facilitates achievement.
g) Imp rovement in labour productivity
There is maximum utilization of manpower. If requires training is
provided to the labour. Benefits of profitable operations are passed on to
the workers in the form of increased wage s and incentives. Workers are
motivated to perform the best. This increases labour productivity.
h) Efficient service to customers
As there is a regular flow of production, it is possible to fix delivery dates
as production proceeds in time. Therefore, th e company can supply the
goods in the market on time. This brings goodwill and customer
satisfaction.
i) Facilitates quality improvement
Proper production planning and control facilitate quality improvement as
necessary checks are undertaken at regular in tervals. Quality can be
upgraded through training sessions, suggestions, schemes, quality circles,
etc.
j) Better work environment
Proper production planning and control provide a better work environment
by providing better working conditions, proper work ing hours, leaves and
holidays, increased wages and incentives, etc.
1.3.3 Importance of Production Planning and Control
Production Planning and control is the managerial function which includes
deciding various issues related to the production process su ch as the use of
the human resource, raw materials, machines working conditions, training munotes.in

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6 to workers, supervision, fixing of targets, etc. It is the technique to plan
every step in a long series of the production process.
Importance of Production Planning and Control can be given with the help
of the following points -
1) Better service to customers
It helps in providing better services to customers in terms of a better
quality of goods at reasonable prices and timely delivery of goods. It
helps in improving customer relations.
2) It helps in a smoother, timely, and efficient production process and
helps in maintaining necessary stock levels.
3) It facilitates effective use of resources such as labour, machinery &
equipment, raw materials and thereby reducing the cost of production
and requirement of working capital.
4) Improvement in the morale of the workers
Efficient production planning & control helps the workers to do their
jobs efficiently. It improves job satisfaction and thereby the morale of
the workers.
5) Image of the organization
A proper system of production planning and control helps in smooth
production operations in an organization. It helps in the timely
delivery of standard quality goods and improving customer
satisfaction. Improved customer satisfa ction results in increased sales,
increased profits, and ultimately good public image of the
organization.
6) Coordinates departmental activities
Proper production planning and control help in coordinating the
activities of the production dept with other de partments such as
finance, marketing, human resource departments.
7) Helps to face competition
With improved performance of production dept, the organization can
improve marketing performance and thereby can face market
competition effectively.
8) Provides be tter work environment
Production planning and control help in providing better work
conditions to the workers to improve their efficiency such as proper
lighting, ventilation, canteen facility, safety measures and so on.
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7 1.4 STEPS IN PRODUCTION PLANNING AND
CONTROL
The production department has to follow the following steps in respect of
production planning and control. These steps are shown in the following
diagram.


1 2
Routing Scheduling



Production Planning
and
Control



3 4
Follow up Dispatching

1. ROUTING
a) Meaning
Routing is the first step in production planning and control. It involves the
selection of the path of work and the sequence of operations for the
completion of the production process in an orderly manner.
b) Objectiv e
The basic objective of routing is to move the work through a variety of
combinations of machines capable of performing the operations required.
It determines the best and the cheapest sequence of operations.
c) Procedure
1. Determining what to make and what to purchase.
2. Determining the material required.
3. Determining the manufacturing operations and their sequences.
4. Determining scrap factor.
5. Preparation of production control forms.
6. Determining lot sizes.
7. Preparation of route sheets.

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8 2. SCH EDULING:
a) Meaning
Schedule means a plan for carrying out a task. It includes a list of intended
events and times. Scheduling refers to deciding the starting and the
finishing date and time of each operation in the manufacturing process. It
involves the preparation of time table of production activities. Scheduling
aims at achieving the required output with a minimum of delay and
disturbance in the production process.
b) Objective
The main objective of scheduling is to ensure the completion of each
opera tion or activity on time. Scheduling ensures continuity in the
production process.
c) Procedure
1. Preparation of timetable.
2. Listing out all production activities.
3. Finalizing a list of all production activities.
4. Determining starting time of e very activity.
5. Determining the finishing time of every activity.
6. Availability of plant capacity, number of operators, and materials
required.
3. DISPATCHING
a) Meaning
Dispatching is concerned with the execution of the production plan. It is
based o n the route sheets and schedule sheets. Production orders are issued
to the factory or department and instructions are issued to execute the
planned production. Dispatching is the action element of production
planning and control.
b) Objective
The purpose of dispatching orders and instructions is to see that the
machine operators understand what is expected of them and that they do
not right things at the right time and complete the production on time.
c) Procedure
1. Arranging machines and tools in a p roper manner.
2. Procuring raw materials as per the requirement.
3. Assigning work to the machine operators and others. munotes.in

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Production Planning and
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9 4. Issuing orders and instructions to the workers.
5. Maintaining a proper record of the start time and finish time of each
operatio n.
6. Dispatching procedure may be centralized or decentralized.
7. Expediting work as per original plan.
8. Control of the progress of all operations.
4. FOLLOW -UP
a) Meaning
Follow -up refers to the monitoring of actual performance. It helps in
taking t he necessary corrective measures to obtain the right quality and
quantity of production.
b) Objective
The basic objective of follow -up is monitoring actual work in the
production process and to introduce remedial measures.
c) Procedure
1. Measuring actua l production.
2. Comparing actual production with planned targets.
3. Finding out causes of deviations, if any.
4. Listing out various corrective measures to correct deviations.
5. Studying or analyzing the corrective measures.
6. Selecting the best correc tive measures.
7. Implementation of corrective measures.
8. Review of corrective measures.
1.5 PRODUCTION SYSTEM
1.5.1 Concept
Production is a process by which goods and services are produced for
consumption. A typical production system comprises three mai n
components i.e. inputs, conversion process, and output. A combination of
various production operations employed to produce goods and services is
known as a production system. A production system is a group of
subsystems. Each sub -system performs a distin ct function.
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10 According to Buffa and Sarin, a production system may be defined as
"the means by which we transform resource inputs to create useful goods
and services as outputs".
1.5.2 Types of Production Systems
The production systems can be broadly divid ed into two groups:
Types of Production System













1. INTERMITTENT SYSTEMS
In this system, goods are manufactured to supply the customers as per
their orders. In this case, there is an intermittent flow of materials.
a) Job production
In jobbing production, one or few units of a product are produced to the
consumer's requirement within the given date. The price is fixed before
the contract. Here, the manufacturer accepts and executes customer's
orders e.g. printing of visiting cards, cal endars, diaries, key chains, etc.
b) Batch production
Batch production is the production of several identical units according to
specific orders or based on demand forecasts. The items are produced in
batches or lots. There exists more standardization and generally, there are
repeat orders. Products are demanded in fairly large quantities e.g.
manufacturing of medicines, chemicals, lubricants, etc.
c) Project production
In project production, a single assignment of complex nature is undertaken
for complet ion within the given period and within the estimated
expenditure. For example, construction of the building, roads, dams,
shipbuilding, etc.
2. CONTINUOUS SYSTEM
Continuous production is a method used to manufacture, produce, or
process materials without interruption. Here, goods are produced Job Production Batch Production Project Production Intermittent Systems Continuous Systems
Mass production
Process production
Assembly production
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11 constantly as per demand forecast. Goods are produced on a large scale for
stocking and selling. They are not produced on consumer's order. The
inputs and outputs are standardized along with the production process and
sequence.
a) Mass production
In mass production, items are produced on a large scale and are stocked in
warehouses till they are demanded in the market. The items are
manufactured with the help of a single operation or a series of operations.
Examples of mass production systems include the manufacture of
toothpaste, soaps, dairy products, textile units, etc.
b) Process production System
In-process production system, a single product type is produced and
stocked in warehouses till it is demanded in the ma rket. The flexibility of
such a plant is almost zero as only one product can be produced. Examples
of process production systems include steel, cement, paper, sugar,
electronic items, toys, etc.
c) Assembly production
Assembly production system developed in the automobile industry in the
USA. A manufacturing unit prefers to use an assembly line as it helps to
improve the efficiency of production. Production cost comes down due to
the use of flow production methods. Assembly line production system is
conven ient when a limited variety of similar products is to be
manufactured on a mass scale or in large batches continuously. The
assembly production system is employed in the manufacturing of
automobiles, radios, T.V., and other electronic products.
Check Your Progress
1. Define the following terms:
a. Production Planning and Control
b. Routing
c. Scheduling
d. Dispatching
e. Follow up
f. Intermittent Systems
g. Continuous system
2. Enlist the objectives of Production Planning and Control.
3. Draw the chart showing the steps of Production Pl anning and Control.
4. Give the examples of the following production systems:
a. Job Production
b. Batch production
c. Project production
d. Mass production
e. Assembly production
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12 1.6 PRODUCTIVITY
Productivity is the ratio of output to inputs. It refers to the volume of
output produced from a given volume of inputs or resources. It is the
amount of output per unit of input. Productivity reflects the amount of
product created by one unit of a factor of production over a specific
period. Productivity expresses the relationsh ip between the outputs from a
system and the inputs which go in its creation. Productivity can be found
out by the following formula
Productivity = Output
Input

According to Peter Drucker, "productivity means that the balance
between all factors of prod uction that will give the greatest output for the
smallest effort".
1.6.1 Factors Influencing Productivity
The factors influencing productivity is shown in the following diagram:

The factors influencing productivity are explained below:
a) Technological factors
The technological factor is the most important. It includes proper location,
layout, and size of the plant and machinery, the correct design of machines
and equipment, research and development, automation, and
computerization, etc. If the organiz ation uses the latest technology then its
productivity will be high.
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13 b) Production factors
The production of all departments should be properly planned,
coordinated, and controlled. The right quantity and quality of raw
materials should be used for produ ction. The production process should be
simplified and standardized. All this will increase productivity.
c) Organisational factors
A simple type of organization should be used. The Authority and
responsibility of each individual and department should be clearly defined.
The line and staff relationships should also be clearly defined. So,
conflicts between line and staff should be avoided. There should be a
division of labour and specialization as far as possible. All this will
increase productivity.
d) Hu man factors
The right men should be selected for the right posts. They should be given
proper training and development. They should be provided with very good
working conditions and working environment. They should be properly
motivated by financial, non -financial, and positive incentives; Incentive
wage policies should be introduced. Job security should be given. Workers
should be given importance. There should be proper transfer, promotion
demotions, and other personnel policies. All this will increase t he
productivity of the organization.
e) Financial factors
Finance is the lifeblood of modern business. There should be proper
control over both fixed and working capital. There should be proper
financial planning. Capital expenditure should be properly co ntrolled.
Both over and under capitalization should be avoided. The management
should see that they get proper returns on the capital which is invested in
the business. If the finance is managed properly the productivity of the
organization will increase.
f) Managerial Factors
The management should be scientific, professional, enlightened, future -
oriented sincere, and competent. They should possess organizational
capacity, imagination, judgment, and willingness to take a risk. They
should make optimum use of the available resources to get maximum
output at the lowest cost.
They should use the recent techniques of management and production.
They should develop better relations with the employees and the trade
unions. They should encourage the employees to gi ve suggestions. They
should provide a very good working environment and they should
motivate the employees to increase their productivity. Efficient
management is the most significant factor in increasing productivity and
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14 g) Governmental f actors
The management should have a piece of proper knowledge about the
government rules and regulations. They should also maintain good
relations with the government monetary facilities, tax concessions for
research and development activities, subsidies , facilities for technology
transfer,etc should be provided by the government. Government has to
provide encouragement and facilities to make the productivity movement
popular in the country.
h) Sociological factors
Productivity also depends on sociologic al factors such as the attitude and
behavior of investors, customers, suppliers, etc. The attitude of workers
and society towards new inventions, social values of the society,
community differences, caste, race, and religion, etc.
i) Natural factors
Prod uctivity also depends on natural factors such as geographic locations,
climatic conditions availability of different kinds of natural resources, etc.
1.6.2 Measures for improving Productivity
Improving productivity is essential for earning more profits an d being
competitive in the business. Productivity in manufacturing is the result of
efficient employees, proper tools, equipment and machinery, and
processes so the management has to look into these areas for improving
productivity. For this, the following measures can be suggested:
1. Study and analysis of the existing system
The management has to identify study and analyze the weak areas as
for as the employees, technology, and processes are concerned.
2. Improvement in the production process
The producti on process can be improved by making proper utilization
of resources such as workers, technology, materials, floor space and
time available, and so on.
3. Providing training to workers
Training has to be provided to workers from time to time to enhance
their skills knowledge and attitudes with proper training, the workers
can do their jobs efficiently and can get job satisfaction.
4. The setting of realistic targets
To improve worker efficiency it’s important to set realistic, clearly
defined objectives. It improves the sense of responsibility and loyalty
and job satisfaction of the workers.
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15 5. Use of modern technology
In mechanical production, it is important to update technology, to
improve productivity and competitiveness in an ever -changing
business environment.
6. Repairs and maintenance
Tools, equipment, and machinery are required to be repaired and
maintained periodically to maintain a smooth flow of the production
process and to ensure industrial safety.
7. Optimum utilization of resources
The m anagers have to ensure the proper use of resources such as
manpower, money, material, and machinery. Wastage or misuse of any
kind should be avoided.
8. To encourage team spirit
The manpower should develop proper coordination and
communication among the w orkers so that they work as a team
towards the achievement of common goals and targets.
1.7 SUMMARY
From the above discussion, it is clear that production management is one
of the important aspects of management, especially in a manufacturing
organizatio n. It is also clear that productionplanning and control are used
in manufacturing organizations. It covers the objectives and steps of
production planning and control. We also understood the types of
production systems and the concept of productivity. As w ell as how the
different factors are influencing productivity.
1.8 EXERCISE
Multiple Choice Questions
1. ___________ is a process of combining various material inputs and
immaterial inputs
a) Production b) Finance c) Selling d) Departmentation
2. Unless g oods are ____________, they cannot be marketed
a) Produced b) Sold c) Purchased d) Advertised
3. ___________ decisions are taken for deciding the product and
production system and time taken for Production
a) Strategic b) Operating c) Non -Operating d) N on-Strategic
4. ______________ decisions are short -term and are acquire to be taken
fore smooth production process
a) Strategic b ) Operating c) Non -Operating d) Non -Strategic munotes.in

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16 5. Production Planning and control is the managerial function that includes
deciding various issues related to the ________process
a) Production b) Finance c) Selling d) Departmentation
6. ___________ Is the first step in Production Planning & Control
a) Scheduling b) Followup c) Dispatching d) Routing
7. ___________ Is the fi rst step in Production Planning & Control
a) Scheduling b) Followup c) Dispatching d) Routing
8. A combination of various production operations employed toproduce
goods and services is known as a __________
a) Production System b) Purchase System c) Selling System
d) Marketing System
9. __________ is a Intermittent system in types of Production system
a) Mass Production b) Process Production c) Job Production d) Assembly Production
10. __________ is a Intermittent s ystem in types of Production system
a) Mass Production b) Process Production c) Batch Production
d) Assembly Production
11. __________ is a Continuous system in types of Production system
a) Mass Production b) Job Production c) Batch Production d) Project Production
12.__________ is a Continuous system in types of Production system
a) Process Production b) Job Production c) Batch Production d) Project Production
13. Productivity is th e ratio of output to________
a) Input b) Output c) Production d) None of the above
14.___________ reflects the amount of product created by one unit of a
factor of production over a specific period.
a) Elasticity b) Selling activity c) Productivity d) N one of the above
15.______________ expresses the relationship between the outputs from a
system and the inputs.
a) Elasticity b) Selling activity c) Productivity d) None of the above
Theory Questions
a) Explain the objectives of production planning and co ntrol.
b) Discuss the steps in production planning and control.
c) What are the different types of production systems? Explain it.
d) What is productivity? Discuss the factors influencing productivity.
e) Explain the types of intermittent systems.
f) Explain the meaning and scope of production management. munotes.in

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17 g) Explain the Measures to be taken for improving Productivity.
h) Discuss the types of continuous systems.
i) Write short notes
a. Production planning and control
b. Production system
c. Productivity
d. Objectiv es of the production management
e. Strategic decisions
f. Operating decisions
g. Importance of Production Planning and control
j) Explain the terms
a. Operating decisions
b. Strategic decisions





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18 2
INVENTORY CONTROL
Unit Structure
2.0 Objectives
2.1 Introduction
2.2 Meaning and Objectives of Inventory Control
2.3 Techniques of Inventory Control
2.4 Methods/Types of Inventory Control System
2.5 Scientific Inventory Control System
2.6 Summary
2.7 Exercise
2.0 OBJECTIVES
After studying the unit the students will be able to -
 Understand the concept of Inventory Control.
 Define the meaning of Inventory Control.
 Know the objectives of Inventory Control.
 Make the students aware of the techniques of Inve ntory Control.
 Elaborate methods/types of Inventory Control System.
2.1 INTRODUCTION
Inventory control is very important in product or service -oriented
business. It is necessary to have the right quantity of material.
Overstocking as well as under stocking is bad. While overstocking can
lead to the blockage of funds, under stocking can lead to a shortage of
supply and may even result in the stoppage of production. In the end, it
may result in improper service to the customer and have an adverse effect
on th e goodwill of the organization.
Production managers are responsible for controlling the costs of
operations. Inventory cost includes amount invested in raw materials,
supplies, work in process, and finished goods. High investment can
increase operating cos ts and decrease production efficiency.
Inventory control is necessary as actual performance may not conform to
planned performance due to changing environmental variables. Inventory
control includes location, stores, and recording of inventories. It suppli es
these inventories to the different departments whenever required. It keeps munotes.in

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Inventory Control
19 a record of each item of inventory. It gives quick and quality service to all
the departments. It not only maintains inventories at the lowest costs but
also avoids overstocking and under stocking of materials.
2.2 MEANING AND OBJECTIV ES OF INVENTORY
CONTROL
"Inventory control is the process whereby the investment in materials and
parts carried in stocks is regulated within the pre -determined limits set
asper the inventory policy established by the management".
2.2.1 OBJECTIVES:
The main objectives of inventory control are as follows,
a) Protection of Stores:
Inventory control is directed towards protecting stores against theft,
unauthorized use, and wastage. This can be done by ma king it difficult for
employees to gain unauthorized possession of materials.
b) Better service to customers:
If the company maintains a proper inventory of raw materials, then it can
deliver its products in time. So, it can deliver the finished goods to the
customers in time. Similarly, if the company has a proper inventory of
finished goods then it can satisfy the additional demand of the customer.
c) Continuity of production operations:
Proper inventory control helps to maintain continuity of productio n
operations. This is because it maintains a smooth flow of raw materials.
So, there are no shortages of raw materials.
d) Better returns on investment:
Shareholder's wealth can be maximized and a better return on their
investment is possible if the inven tory is at an optimum level. Inventory
control ensures the proper use of limited funds.
e) Buffer to reduce uncertainty:
There can be an irregular supply of raw materials due to transportation
problems or even due to natural causes. In such a scenario the re arises a
need to have a buffer stock to protect against such vagaries. Buffer stock
maybe even sometimes necessary to meet the unexpected surge in
demand.
f) Ensures continuity of supply:
Inventory control explains when to order and how much to order. It
ensures continuity of supply of uniform quality of goods at the lowest
cost. It is possible to calculate fluctuations in the supply of new materials
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20 g) Useful during peak season:
Some companies adopt a strategy of producing during the slack season
when the cost of production is less. This excess stock can be effectively
sold at a higher price during peak season, The reduced cost during the
slack season more than offsets the cost of maintaining inventor y.
h) Avoid duplication in ordering:
Inventory control avoids duplication in the ordering of stock. This is done
by having a separate purchase department. This department will do all the
purchasing for the organization. No other department is allowed to d o
purchasing.
i) Focus on Inventory:
In a production unit, inventory control focuses on materials control
because the main concentration is on the physical product. In the service
sector, the focus is on service which is consumed promptly. The main
concen tration is more on the supply of service and less on materials. For
example banks, transport companies, educational institutions, etc.
j) Avoid wastage:
Inventory control helps to maintain a check on the loss of materials due to
carelessness or pilferage. If there is no proper inventory control, then there
are more chances of carelessness and pilferage by the employees,
especially in the store -keeping departments.
2.3 TECHNIQUES OF INVENT ORY CONTROL
There are several techniques of inventory control. Some o f the commonly
used techniques are as follows.
a) ABC Analysis:
ABC (Always Better Control) analysis is a basic technique of inventory
control. This technique can be used for all aspects of materials
management such as verification of bills, purchasing, r eceiving,
inspection, store -keeping, issue of stores, inventory control, etc. ABC
analysis classifies all the items in the inventory into three groups i.e. A
group, B group, and C group
A group of items hasa high value although their number may be low. B
group of items are in between with average value and number. C group of
items has very low value but their number may more.
ABC analysis provides a basis for selective inventory to a small number of
items which account for most of its inventory costs. So, i t can concentrate
on controlling these items, on the other hand, low cost, and high volume
items need not be closely controlled.
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21 b) Economic Order Quantity (EOQ):
In Economic order Quantity, the fixed order quantity of materials is
ordered when the stock on hand reaches the re -order point. The re -order
point is the inventory level at which the stock should be re -ordered for the
smooth flow of production.
c) Just -in-Time (JIT):
The Just -in-Time technique was started by a Japanese company. Here the
company does not have a warehouse and it does not maintain any
inventories at any stage of production. The exact quantities of materials
are purchased at the right time at each stage of production. A truck
delivers raw materials at one gate at the same time truck will take finished
goods from another gate to the market.
This system can't be used by all companies for all materials. However, in
India, Maruti Udyog Ltd, and Food specialist Ltd have successfully used
the JIT technique.
d) CARDEX system:
In the Cardex system, cards are vertically arranged in a tray and kept in
cabinets. Posting in this card may be done manually. However, nowadays
computers are taking over the place of manual posting. The cards are
known as 'stock control cards' are of different types, sizes, and colors. The
cards indicate the position of stock which includes stock of items ordered,
stock items received from suppliers, stock of items issued, the balance of
stock, etc.
e) The maximum -minimum system:
It refers to the maximum, minimum quan tity of inventory. Maximum
inventory is that quantity which the company must keep in stock, when the
stock reaches its minimum quantity, an order is placed to bring the stock
up to the maximum level.
f) Two -Bin system:
Here the materials are kept in twobi ns. The first bin is locked and kept as
reserve stock. The second bin is kept open, materials are used from the
second bin for the production process. When the material from this bin is
over, an order is placed for purchasing more materials. Then the first bin is
opened and the materials are used from this bin.
g) MAPICS (Manufacturing Accounting and Production Information
Control System):
MAPICS is a computerized common data -based system for manufacturing
information and control. In simple words, entire d ata relating to
manufacturing i.e. the inventory required, the production schedule, type of
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22 becomes easy as any information relating to stock level is readily
available.
In this sys tem, there are various modules for control. Modules can be
relating to product data management, material requirements planning,
inventory management, and so on.
h) Inventory turnover ratio (ITR):
This technique of inventory control uses accounting ratios such as
Inventory Turnover Ratio. This technique establishes the relationship
between average inventory and cost of inventory consumed or sold during
a fixed period. The following formula is used to calculate the inventory
turnover ratio.
Cost of goods con sumed or sold during the year
ITR =
Average inventory during the year

When consumption is made between current years inventory ratio with
those of past years, it will reveal information such as obsolete, fast -
moving items, and slow -moving items.
Check Y our Progress
1. Enlist the objectives of Inventory Control.
2. Define the following terms.
a. Inventory control
b. EOQc.JIT
d. Cardex System
e. ABC analyses
f. MAPICS
g. ITR
2.4 METHODS/TYPES OF INVENTORY CONTROL
SYSTEM
While designing an inventory control sy stem, three questions are taken
into account namely: -
1) How often the assessment of stock should be made?
2) When should the replenishment order be placed?
3) What should be the size of the order?

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23 The following are the methods/types of the inventor y control system.
a) The two -bin system:
The two -bin system is one of the oldest systems of inventory control. It
provides an answer to two questions i.e. 1) when the order should be
placed? 2) How much quantity should be ordered?
This system is illustrat ed as follows:







Bin No. 1 Bin No. 2





Use Bin No. 1 Use Bin No. 2
Till it is empty when Bin No. 1 is empty

In this system, two bins are used and the stock is divided into two bins.
The first one is used for satisfying current demand and t he second one is
used during the replenishment period. The second bin is used only when
the first bin is empty and the replenishment order is placed. When the
replenishment order is received, first the second bin is filled and then the
balance is put in th e first bin.
b) Open -access Bin System:
Open -access Bin System, the operators access the material directly
without maintaining any records. This saves their time which can be used
productively for the production purpose. It is the organization several suc h
open access bins are used, a store vehicle can move around these bins at
fixed intervals to replenish the stock. In this method, the quantity
replenished is assumed to be the quantity consumed.
c) Re -order Level System:
In this system, the maximum level and minimum level are fixed. Here re -
ordering is done after a period of review and order or re -order is placed
when the quantity reaches a certain level. The following graph shows a
typical stock replenishment system.
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24

The above diagram represents an av erage rate of consumption of 100 units
per month. The supplies are purchased once in three months (300units).
The minimum level/Buffer stock is maintained at 100 units i.e. equivalent
to one month's consumption. The lead time, in this case, is 45 days. Thi s
means that when the stocks reach a level equal to 45 days consumption
above the minimum level, a replenishment order is placed. The re -order
level is at 250 units. The maximum stock held is 400 units.
In reality, it is not necessary that the consumption curve may be as smooth
as illustrated above. To assess the consumption level it is necessary to take
into account the sales forecast and experience to arrive at a monthly
consumption pattern.
The above system is also referred to as a maximum -minimum reorde r
system or fixed quantity system.
d) Fixed Time system:
In this method, instead of considering the stock level, the time factor is
taken into account. Here, orders are placed at regular intervals of time
say15th of March, June, etc. This method is also c alled the constant cycle
system. The time for replenishment order is chosen purely from the point
of view of administrative convenience. The number of orders to be placed
is determined based onthe EOQ formula.
e) Imprest stock control:
This is the simples t method of inventory control and here the maximum
level for the bin is determined and periodic inspection of stock level in the
bin is undertaken. As and when the stock is used the bin is replenished
immediately to the maximum level. This method is restri cted to material
of low value (classification 'C' material). A stock -out situation can be
easily rectified as the stock is easily available.
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25 2.5 SCIENTIFIC INVENTORY CONTROL SYSTEM
The purpose of the Scientific Inventory Control system is to avoid the
dangers of overstocking and under stocking of materials, work -in-
processes, and finished products.
2.5.1 Importance of Scientific Inventory Control System :
1. It ensures smooth flow of production processes by making the right
quality of materials at right time .
2. It reduces ordering cost
There are certain overhead costs involved in ordering supplies. It is
possible to avoid frequent ordering of requirements if the organization
has a scientific inventory control system.
3. It minimizes locking up of working capit al in inventories
With a proper inventory control system, it is possible to minimize the
locking up of working capital in excess inventories and to improve the
liquidity position of the firm.
4. It helps in the supply of goods as per the market demand
If there is sufficient stock of goods in hand, it is possible to supply
goods as per the demand. It helps to satisfy customers and improve the
market image.
5. It helps in getting quantity discounts
For bulk orders, the organization gets the benefits of trade dis counts
from the suppliers. These discounts can reduce the cost of goods and
increase profits.
6. It helps in taking the advantage of price fluctuations
The firm can make purchases in bulk lots, when the prices of raw
materials are low, thereby reducing the cost of raw materials. The firm
can also take the benefit by marketing goods when the prices are
higher. Thus, by taking the advantage of price fluctuations, the firm
can maximize profits.
7. It helps in deciding timely replenishment of stocks
A proper inve ntory control system helps in keeping up -to-date records
of the inventories. It helps the firm to avoid thefts, wastages, and
leakages of inventories. These records also help in deciding about the
timely ordering of stocks.
2.6 SUMMARY
Inventory control h as been a must in running a business or an
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26 and placement of stocked goods. The scope of inventory management also
concerns the fine lines between replenishment lead time, carrying co sts of
inventory, asset management, inventory forecasting, inventory valuation,
inventory visibility, future inventory price forecasting, physical inventory,
available physical space for inventory, quality management,
replenishment, returns, and defective goods and demand forecasting.
Balancing these competing requirements leads to optimal inventory levels,
which is an ongoing process as the business needs shift and react to the
wider environment.
Inventory management functions techniques related to the tra cking and
management of material. This would include the monitoring of material
moved into and out of stock room locations and reconciling the inventory
balances. Also may include ABC analysis, JIT, lot tracking, cycle
counting support, etc.
Management of the inventory, with the primary objective of
determining/controlling stock levels within the physical distribution
function to balance the need for product availability against the need for
minimizing stock holding and handling costs. Therefore design an
inventory control system by the way i.e. the Two -bin system, open access
Bin system, Re -order level system, Fixed time system, and Impress stock
control.
2.7 EXERCISE
Multiple Choice Questions
1. ___________ managers are responsible for controlling the
costs of operations.
a) Production b) Finance c) Selling d) Purchase
2. __________ means ABC Control
a) Always Better Control b) Any Body Control c) Always Best
Control d) Anyways better cost
3. ABC analysis classifies all the items in the inventory into
____________ groups
a) Three b) Two c) One d) One
4. In ______________ technique the company does not have a warehouse
and itdoes not maintain any inventories at any stage of production
a) ABC Analysis b ) Just in Time c) CARDEX System d) Two Bin
5. In T wo bin System the __________bin islocked and kept as reserve
stock
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27 6.In Two bin System the __________bin is kept open,materials are used
from the second bin for the production process
a) First b ) Second c) Third d) Fourth
Theory Questions
1) Define inventory control. Explain the objectives of inventory
control.
2) Discuss the techniques of inventory control.
3) What are the methods/types of inventory control systems? Explain it.
4) Write short notes
i) Inventor y control
ii) ABC Analysis
iii) JIT
iv) The Two -Bin system
v) Re-order level System
vi) Scientific Inventory Control system





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28 3
QUALITY MANAGEMENT
Unit structure
3.0 Objectives
3.1 Introduction
3.2 Introduction to Quality
3.3 Quality Control
3.4 Quality Circle
3.5 Summary
3.6 Exercise
3.0 OBJECTIVES
After studying the unit the students will be able to
 Know the concept of quali ty management
 Understand the concept of quality control
 Makes the students aware of the techniques of quality control.
 Study the concept quality circle.
 Evaluate the process of a quality circle.
3.1 INTRODUCTION
Quality management takes measures to control the quality of the
future output. ISO 9000 is the only internationally accepted standard for
quality management. The development of quality management has seen
four phases i.e. a) quality planning b) quality control c) quality assurance
and d) quality imp rovement. Quality management improves the
competitiveness and reputation of the firm. It ensures satisfaction to
customers through the guarantee of goods, safe performance, efficient
service, and prompt delivery.
Quality management is concerned with qualit y production through regular
inspection during the process of production. Quality is a combination of
characteristics of the manufacture of the product and control is the
correction in the quality of the product as and when the deviations in the
product ar e more than expected. A good quality item confirms some
standard specifications. These specifications are determined by the
expectations of consumers and also by the availability of processes and
materials.
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29 Definition of Quality Management:
"Quality manag ement uses quality assurance and control of processes as
well as products to achieve more consistent quality".
3.2 INTRODUCTION TO QUALITY
Quality is the degree to which a product, process, or service satisfies a
specified set of attributes or requirement s. It is a relative term because
specifications or requirements differ from person to person or organization
to organization.
3.2.1 Dimensions of Quality
The following are the dimensions of quality that can be used to
determine/decide the quality characte ristics.
1. Performance:
Performance of a product/service refers to a product's primary
operating characteristics. It decides whether it can perform well to
fulfill the need or requirements of the consumer.
2. Features:
Features are additional or supplementary characteristics that enhance
the utility or performance of the product/service. These features
supplement the basic functioning of the product/service.
3. Reliability:
Reliability indicates the specified working life of the product, and it’s
a kind of assur ance that the product can be used for the specified
period without fail.
4. Conformance:
The dimension of conformance refers to the degree to which a product
design and operating characteristics meet established standards. It is a
kind of quality assurance g iven by the organization to the customers.
5. Durability:
Durability refers to the length of a product’s life. With proper
handling, repairs, and maintenance, the product’s life can be increased
to a certain limit.
6. Serviceability:
Serviceability refers to h ow efficiently the organization can provide
repairs and maintenance service to the customers if the product fails to
operate.
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30 7. Aesthetics:
Aesthetics is the relative / subjective term and it refers to how the
product looks, feels, sounds, tastes, and smel ls. It is a matter of
personal performance a judgment.
8. Perceived Quality:
Very often consumers do not get or have complete information about a
product’s or service’s attributes. They may select the particular brand
based on other factors such as the organ ization’s and brand’s image,
advertising message, feedback from the customers, and so on.
3.2.2 Cost of quality :
Meaning
Cost of quality refers to the cost involved in activities and resources for
preventing detecting and remediating manufacturing of poo r quality of
goods/services.
Quality costs are categorized / Types into four main types and they are -
1. Prevention Costs:
It is always better to take measures to prevent defects in manufacturing
products. The costs which are incurred to avoid or minimize the
defects in manufacturing costs are known as prevention costs. Such
costs can include costs incurred for improvement of manufacturing
processes, training to workers, repairs, and maintenance of machinery,
etc.
2. Appraisal Costs:
Appraisal or Inspection c osts are those costs that are incurred to
identify defective products before they are sold to customers. These
costs include supervision or inspection costs for maintaining a team of
inspectors. It helps to ensure the production of products with required
quality standards.
3. Internal failure costs:
Internal failure costs are those costs that are incurred to remove defects
from the products before selling them to customers. They include the
cost of rework, rejected products, scrap, etc.
4. External failure cost s:
External failure costs are incurred if the defective goods are sold to
customers. They include the costs like warranties replacements, sales
returns, etc. It also covers the damages such as spoiling of market
reputation & goodwill unsatisfied customers reduced sales and profits.
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31 3.3 QUALITY CONTROL
In every manufacturing concern, quality control plays a very important
role. In most organizations, there isa separate quality control division with
well-equipped tools, machines, etc. Before producing the a ctual product its
design has to be prepared. Product quality is the degree to which such
actual output conforms to the design. It is physically impossible to make
all the items alike. There is always variability in the product. When
variability becomes not iceable its results in scraps, rework, and losses,
thus adding to the cost. Quality control takes measures to control the
quality of the future output. Quality control is concerned with quality
production through regular inspection during the process of pr oduction.
3.3.1 DEFINITION OF QUALITY CONTROL:
According to Alford and Beatty, "Quality control is those techniques by
which products of uniform acceptable quality are manufactured".
3.3.2 Techniques of Quality Control
The following are the techniques of q uality control
a) Inspection:
Inspection is an important technique of quality control. It means testing a
product to ensure that it meets its design specifications. It involves critical
appraisal involving examination, measurement, testing, gauging, and
comparison of materials or items. An inspection determines if the material
or item is in proper quantity and condition and if it conforms to the
applicable or specified requirements.
Inspection can be defined as "an act of monitoring or observing a process,
procedure or service to ensure compliance with the operational definition
and to ensure that all customer requirements or internal prerequisites are
met.
b) Just -In-Time (JIT):
Just-In-Time is an important technique of quality control. The quality of
finished products depends on the quality of raw materials. Manufacturers
enter into a contract with the suppliers to supply raw materials Just in time
and enable to manufacture quality products in time and economically.
Just-in-time assumes the use of sophist icated technology to maintain a
high quality of production.
Just-in-time supports the adoption of preventive maintenance of the plant
to avoid machine breakdowns. Preventive maintenance goes a long way to
ensure continuous production. Due attention should be given to train and
develop employees who are largely responsible to provide quality goods
and services.
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32 c) Total Quality Management (TQM):
Total Quality Management (TQM) is a management approach that
originated in the 1950s and has steadily become mor e popular since the
early 1980s. It is an integrated organizational effort designed to improve
quality at every level. In a TQM effort, all members of an organization
participate in improving processes, products, services, and the culture in
which they wor k.
At its core, TQM is a management approach to long -term success through
customer satisfaction. It seeks to improve quality and performance which
will meet or exceed customer expectations. This can be achieved by
integrating all quality -related functions and processes throughout the
company. TQM looks at the overall quality measures used by a company
including managing quality design and development quality control and
maintenance, quality improvement, and quality assurance. TQM takes into
account all qual ity measures taken at all levels and involving all company
employees. TQM is undertaken continuously.
TQM can be defined as "an integrative philosophy of management for
continuously improving the quality of products and processes".
d) Quality at the source :
Under quality at the source technique, each employee is made responsible
to produce quality parts before they are given to the next operation. Each
employee is expected to conduct self -appraisal of work. He should
evaluate his performance, note defects, and introduce corrective actions. In
case the defect in the product continues, he is allowed to stop his part of
the work rather than continue to make defective parts. In situations of this
nature, the quality circle is of great help to mutually work out suitable
solutions.
e) Statistical Quality Control (SQC):
In today's economic activity, the need to make the optimal use of
resources for the manufacture of goods and services of high quality at a
low cost and to market them at a competitive price has acq uired great
significance. Consequently, there has been a growing demand for persons
trained in the techniques and approach of quality control. The Statistical
Quality Control (SQC) process relates to the use of statistical methods of
monitoring and control to reduce wastes in the production activity and
make sure that confirming goods are being produced. Although this
process has been mostly applied in the control of manufacturing lines, its
applicability can be extended to any process with a measurable out put.
SQC evaluates the quality of a product, service, or process. It is used to
analyze quality problems and solve them. It is used by quality
professionals.

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33 f) Quality circles:
Quality circle is based on the concept of participative management. It
assumes that quality improvement is possible by uplifting morale and
motivation through consultation and discussion in informal groups. The
circle consists of operators, supervisors, and managers who come together
to improve ways to make quality products or de liver the service. Members
are trained in problem -solving techniques. Members forward
recommendations to the management for implementation.
Check Your Progress
1. Define the following terms:
3.4 QUALITY CIRCLE
This concept was first introduced in Japan by Mr. Kaoru Ishikawa. The
quality circle was formed to promote the concept of quality. The concept
of quality control is based on the management's faith in the c apabilities of
employees. Quality control is a small voluntary group of people from the
same work area who meet regularlyto identify, select, analyzing and
solving work -related problems of quality, productivity, cost reduction,
safety, customer service, et c. The Quality circle members select problems
in their immediate work environment through the process of discussion
and deliberation to identify possible solutions for the same. Quality circle
is a people -building philosophy, providing self -motivation and happiness
in an improving environment without any compulsion or monetary
benefits.
3.4.1 Meaning:
A quality circle is a small group of volunteered employees from the same
work area, doing similar work, who meet regularly to identify, analyze and
solve prob lems in their work field.
3.4.2 Process of Quality Circle
Quality circle is teamwork for quality improvement. It is a voluntary and
self-service activity useful to the company, employees, and the national
economy. This concept has its philosophy with wide meaning and
significance. The quality circle needs a suitable organizational structure
for effective internal communication and efficient functioning. Quality
circles are not merely for studying, analyzing, and suggesting solutions but
for the implementati on of concrete results about quality, cost, and a. Quality management
b. Quality control
c. Inspection
d. JIT
e. TQM
f. Quality at the source
g. SQC
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34 productivity. Quality circle is based on workers' initiative. Strictly, it is a
participative program on a purely voluntary basis.
The following are the process of the Quality circle
a) Listing of problems:
The first step in the process of the quality circle is the listing of problems.
It means list out the problems. Such listing of problems can be done by
management or employees.
b) Selection of problem:
The second step in the process of the quality circle is a selection of
problems. It involves discussion over the list of problems. The quality
circle members select one problem at a time to work on.
c) Analysis of the problem:
The problem selected by the members is thoroughly analyzed. The quality
circle ca n approach management with a request to provide an expert or
consultant so that the analysis gets professional touch.
d) Generating Solutions:
As members of the quality circle discuss only quality matters it is possible
to arrive at a workable solution. S ometimes technical issues may drag on
and the solution is obtained in more than one sitting. The circle is allowed
to work out more than one solution. Alternative solutions need to be
evaluated in the light of specified objectives. Compare costs and benefi ts
of each solution and the quality circle should recommend the best solution
to top management.
e) Recommendations:
As a practice, the quality circle recommends the solution to its
departmental head which finally reaches the top management. The
decision of top management will be final. Top management will also
consider the recommendation of the quality circle. Nowadays the quality
circle provides audio -visual presentation. The presentation should be self -
explanatory. Nothing is left to the imagination of top management and
every point is well illustrated and explained.
f) Acceptance of Recommendations:
The management will closely scrutinize the solution. They will consider
the pros and cons of the solution. They will also evaluate its practical
utility. I f the management is convinced about the soundness of the solution
it will approve the project and sanction the requisite amount.
g) Implementation:
The management then implements the decision. Implementation often
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35 circle. The team spirit among the workforce ensures proper
implementation of the decision.
h) Rewarding the employees:
The quality circle member is recognized and rewarded for their positive
and fruitful recommendations.
3.4.3 Features / Characteristics of quality Circles:
A quality circle is a small group of employees who voluntarily join hands
to solve day -to-day work -related problems such as wastage of materials,
quality of raw materials, tools, semi -finished and finished good s, work
environment, scheduling, maintenance of machinery, safety measures, and
so on. They solve the problems with the guidance and advice of their
supervisor.
The following are the characteristics/features of the quality circle:
1. It is a group of workers /employees doing a similar kind of job.
2. It is a group of few members maybe three to ten to achieve better
communication and coordination.
3. Members join the circle voluntarily. They feel the need to identify and
solve work -related problems.
4. Generally, mee tings of the circle take place for at least an hour every
week at a time suitable to all members.
5. The quality circle is formed basically to find out solutions to the work -
related issues/problems. So the supervisor, who is in charge of the
work, generally acts as a leader of the group.
6. The members of the group are concerned only about the issues related
to their work area only.
7. After studying and analyzing the problem related to the work, the
members collectively find out the solutions for the problems an d they
are forward to the management for their approval.
After the management’s approval, the circle members can implement the
measures for overcoming the problems.
3.5 SUMMARY
Quality management is concerned with controlling activities to ensure that
products and services are fit for their purpose and meet the specifications.
Quality control takes measures to control the quality of the future output.
Quality control is concerned with the quality of production through regular
inspection, Just -in-time, tota l quality management, quality at the source,
statistical quality control, and quality circle techniques during the process
of production. The main objective of quality control is to ensure that the munotes.in

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36 business is achieving the standards it sets for itself. Qu ality circles are
designed to improve employee morale, Job efficiency, management
procedures, and the quality of a firm's products. Although most commonly
found in manufacturing environments, quality circles apply to a wide
variety of business situations a nd problems. They are based on two ideas,
that employees can often make better suggestions for improving work
processes than management, and that employees are motivated by their
participation in making such improvements.
3.6 EXERCISE
3.6.1Multiple Choice Questions
1. ___________ takes measures to control the quality ofthe future output.
a) Quality Management b) Inventory Management c)Financial
Management d) None of the Above
2. __________is concerned with quality productionthrough regular
inspection durin g the process of production
a) Quality Management b) Inventory Management c)Financial
Management d) None of the Above
3. ____________ refers to the cost involved in activities and resources for
preventing detecting and remediatingmanufacturingof poor quali ty of
goods/services.
a) Cost of Quality b) Cost of Quantity c) Cost d) Quality
4_____________ is thosetechniques by which products of uniform
acceptable quality aremanufactured
a) ABC Analysis b ) Quality Control c) Quality Management
d) Cost of Quality
5. _____________ process relates to the use of statistical methods of
monitoring andcontrol to reduce wastes
a) Statistical Quality Control b) Quality Control c) Statistical Process
d) None of the above
6. ______________ is based on the concept of participativemanagement
a) Cost of Quality b ) Quality Circles c) Quality Management d) Quality Management
7. ____________ assumes that quality improvement is possible byuplifting
morale and motivation through consultation and discussionin informal
groups
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37 8. A ___________ is a small group of volunteered employeesfrom the
same work area, doing similar work, who meet reg ularly toidentify,
analyze and solve problems in their work field
a) Cost of Quality b ) Quality Circles c) Quality Management
d) Total Quality Management
Theory Questions
a) Explain the techniques of quality control.
b) Discuss the p rocess of the quality circle.
c)Explain the term Quality Circles and its Characteristics
d) What are the dimensions of Quality
e) What are the types of Quality
f) Write short notes
i) Quality management ii) Quality control
iii) Quality at the source iv) In spection
v) Total Quality Management (TQM) vi) Just -In-Time (JIT)
vii) Statistical quality control (SQC) viii) Quality circle




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CONTEMPORARY TRENDS IN QUALITY
MANAGEMENT
Unit structure
4.0 Objectives
4.1 Total Quality Management (TQM )
4.2 Six Sigma
4.3 Steps in Six Sigma
4.4 International Standards Organisation (ISO 9000)
4.5 Procedure to Obtain Iso 9000
4.6 Kaizen
4.7 Service Quality Management
4.8 Summary
4.9 Questions
4.0 OBJECTIVES
After studying this chapter the students will be able to -
 Understand the meaning and features of total quality management.
 Know the meaning and features of six sigma as well as the steps in
six sigma.
 Bring out the meaning and procedure of ISO 9000.
 Elaborate on the kaizen process.
 Evaluate service quality management and its importance.
4.1 TOTAL QUALITY MANAGEMENT ( TQM )
Total Quality Management is a comprehensive concept and not related
only to the quality of goods and services. It is a wide term that is
concerned with an overall improvement of the system, techniques, and
staff of the organization. Total quality management is a preventive
approach and not a corrective one. It aims at producing t he best possible
product and service through regular innovation. It believes in doing the
right things the first time. TQM is a strategic approach to produce the best
possible product and service through constant innovation and timely
action. It is always focused on the requirements of the customers both
internal and external.
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39 TQM is a management philosophy the places emphasis on continuous
improvement in quality in the interest of the organization and that of its
customers.
Definition:
According to prof K.K.Chaudhari "TQM represents a customer -
oriented, quality -focused management philosophy".
4.1.1 FEATURES OF TOTAL QUALITY MANAGEMENT
The following are the main features of Total Quality Management
a) Continuous process:
Total Quality Management is a cont inuous process. The managers are
continuously trying to find out new methods and techniques for improving
the quality. They also encourage the employees to give their ideas and
suggestions for improving the quality. Quality improvement helps the
organizati on to face the challenges of the competitors and to meet the
requirement of the customers.
b) Customer Focus:
TQM gives great importance to customers. It tries to give maximum
satisfaction to the customers. TQM tries to give the customers a regular
supply of good quality goods and services at a low cost. It tries to avoid
wastage, rejection, etc. It tries to protect the customers in all ways. TQM
believes that if the organization cannot satisfy and protect the customers,
then the customers will be attracte d by the competitors.
c) Defect -free Approach:
TQM emphasizes defect -free work most of the time. It follows a zero -
defect approach. i.e., It tries to produce goods with zero (no) defects.
TQM aims for perfection. It works hard to achieve perfection. It gi ves
more importance to prevention and less importance to rectification. i.e., it
tries to prevent errors and mistakes. It tries to be "right first time" and all
times.
d) Employees Involvement:
TQM is possible only through participative management. Under TQM,
employees will be motivated to participate actively in the process of
quality improvement through incentives, rewards, and recognition. TQM
creates teamwork where workers are trained and motivated properly. In
TQM everyone is involved in the process f rom the managing director to
the junior clerk or worker in the organization.
e) Linkage of quality and productivity:
TQM technique is useful for improving quality as well as productivity.
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40 makes all employees responsible for quality maintenance and
improvement. It also leads to higher productivity.
f) Recognition and Rewards:
In TQM, the employees are encouraged to improve the quality. They are
encouraged to give suggestions about how to improve the quality. TQM
offers recognition and rewards to the employees for improving quality.
Recognition means encouraging individuals and groups by giving them
letters of thanks, merit certificates, inviting them for lunches, dinners, etc.
Rewards mean to encourage individuals and groups by giving them
financial benefits such as merit pay, promotion with higher status and pay,
etc.
g) Synergy in Team Work:
The Japanese are great believers in Synergy. Synergy means to work
together. In Japan, there is no status difference between an engineer and an
ordinary worker. Both are treated equally by each other. They work side
by side as a team. So, TQM gives importance to teamwork. Without
teamwork, we can't have TQM.
h) Techniques:
TQM needs the use of variou s techniques such as quality circles, value
engineering, statistical process control, quality assurance, etc. With the
help of such techniques, it is possible to improve the quality and reduce
time-consuming low -value activities.
i) Management involvement:
TQM is a systematic approach for managing business and improving
performance. Management participation is necessary for the success of
TQM. It requires total commitment from the top management to provide
good leadership to the whole approach.
4.1.2 IMPOR TANCE OF TOTAL QUALITY MANAGEMENT
The following is the importance of Total Quality Management
a) Cost Reduction & Increased Profitability :
TQM helps reduce total quality costs. In other words, it aims to produce
superior quality products and services so t hat no additional costs are borne
later. Many companies like Apple, Microsoft, etc. implemented TQM
techniques to reduce manufacturing costs, saving billions of dollars.
b) Enhanced Productivity :
Some organizations offer superior quality resources, high -end
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41 motivating employees. With improved standards of work and better
working conditions, employees are encouraged to maximize their output.
c) Lesser Redundancy :
Every organization ai ms at improving productivity and profitability. TQM
uses a systematic approach to reduce any duplication of tasks, therefore
saving time and fully utilizing available resources.
d) Improved Innovation Process :
As we’ve already established, TQM includes a research phase.
Organizations collect data about any current challenges or problems to
devise effective solutions. Some organizations rely on unique strategies to
get to the root of a problem. For example, businesses often use the A/B
testing method to com pare two versions of the same strategy and
implement the one that produces better results.
e) Continual Improvement :
As we’ve already established, TQM includes a research phase.
Organizations collect data about any current challenges or problems to
devise effective solutions. Some organizations rely on unique strategies to
get to the root of a problem. For example, businesses often use the A/B
testing method to compare two versions of the same strategy and
implement the one that produces better results.
f) Effective Communication :
TQM techniques push individuals to collaborate and support each other
for the greater benefit of an organization. Increased teamwork and cross -
functional collaboration prompt everyone to strive for continuous
improvement. For exa mple, clear communication enables a production
chain that functions seamlessly because everyone is on the same page.
g) Holistic Approach To Management :
Many organizations struggle with low employee engagement. TQM helps
workplaces bring behavioral change s by facilitating self -development,
teamwork and improved employee engagement. Individuals show more
interest in their roles because the organization prioritizes their well -being
and job satisfaction.
h) Increased Goodwill :
Organizations can establish qua lity standards for goods/services using
TQM. Internal stakeholders (employees and investors) get lucrative
incentives and profitable return on investment. External stakeholders
(customers and clients) get superior quality products and services. The
result: positive brand image and goodwill in the long -run.

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42 i) Satisfied Customers :
High -quality products that meet customers’ needs results in higher
customer satisfaction. High customer satisfaction, in turn, can lead to
increased market share, revenue growth via upsell and word -of-mouth
marketing initiated by customers.
j) Well -defined cultural values :
Organizations that practice TQM develop and nurture core values around
quality management and continuous improvement. The TQM mindset
pervades across all aspe cts of an organization, from hiring to internal
processes to product development.
4.2 SIX SIGMA
In 1986, Bill Smith, a Motorola engineer, developed the six sigma
program. Six Sigma is a set of tools, techniques, and strategies designed
for process improvem ent. Six Sigma attempts to improve the quality of
process output by identifying and removing the cause of defects or errors.
It minimizes variability in manufacturing and business processes. Under
six Sigma Motorola defined six standard deviations of varia tion which
could be squeezed within the limits defined by their customer's
specification.
4.2.1 Features of Six Sigma
The following are the main features of Six Sigma.
a) Problem -solving approach:
Six Sigma adopts a structured approach towards problem -solving. The
most commonly used version of the problem -solving methodology is
known as DMAIC. It stands for D -Define M -Measure A -Analysis I -
Improve C -Control an acronym for the phases of Six Sigma improvement.
This methodology defines a problem and works to fi nd a solution.
b) Reduced process variation:
Process variation takes up when the production activities are uneven, To
maintain uniformity in production firms use Six Sigma. It brings about
stable and predictable process results. As a consequence, process variation
gets reduced.
c) Based on Factual Data:
There is no place for assumptions and guesswork in Six Sigma. The entire
operation of Six Sigma is based on factual data and statistical methods. All
decisions are taken only when reliable data is collecte d, analyzed, and
interpreted. Such finding must reflect the ground reality. Only then it can
be put into practice.
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43 d) Team -Based:
Six Sigma is team -based and the structured nature of this approach
required extreme discipline within the organization which includes time
management and pro -active leadership but the real challenge lies in the
ability to plan and execute projects which deliver specified financial
benefits.
e) Improved market Image:
As quality products are rolled out consumers get money's wort h and they
continue their patronage for the same product. Moreover, the name of the
company gets established in the market as the maker of quality products.
The improved market image continues to rope in new customers.
f) Customer Focus:
Six Sigma has a v ery strong customer focus. The targets are set keeping in
mind the requirements of the customers. The customer focus is
fundamental to the Six Sigma approach. The quality improvement and
control standards are based on explicit customer requirements.
g) Org anisational commitment:
Six Sigma should not be used as a decorative piece. It must be based on
the active support, involvement, and commitment of management and
employees. Top management is committed to improving quality. The
managers must display their capabilities from planning to work to plan for
the accomplishment of specific goals.
h) Better Approach:
Six Sigma enables to measurement, analysis, control, and improve the
manufacturing process. Even total business operations are kept under
control. Six Sigma is a better approach because it is result -oriented.
i) Continuous Improvement:
Six Sigma is all about continuous improvement. Like all other quality
improvement initiatives, its ultimate aim is to refine the processes within
the organization leadin g to the improvement of the quality of the produced
output. Therefore management must decide on priority areas of
improvement.
4.3 STEPS IN SIX SIGMA
The steps in Six Sigma are as follows:
1. DEFINE PHASE:
There are five high -level steps in the application of Six Sigma to improve
the quality of output. The first step is to Define. During the define phase,
the important major takes are undertaken i.e. formation of project team,
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44 and develop the Suppliers, Input, Process, Output,Customers (SIPOC)
process map. This step helps to know who the customer or end -user is,
their resistance issues, and requirements. You should also have a clear
understanding of goals and the scope of the project inclu ding budget, time
constraints, and deadlines.
2. MEASURE PHASE:
The second step or phase of Six Sigma is a measured phase. During the
measure phase, the overall performance of the core business process is
measured.
There are three important part of the meas ure phase
i) Data collection plan and data collection:
A data collection plan is prepared to collect the required data. This plan
includes what type of data needs to be collected, what are the sources of
data etc. The reason to collect data is to identify areas where current
processes need to be improved.
ii) Data evaluation:
At this stage, collected data is evaluated and Sigma is calculated. This
gives the approximate number of defects.
iii) Failure mode and Effects Analysis (FMEA):
The final segment of the measure phase is called FMEA. This refers to
preventing defects before they occur. The FMEA process usually includes
rating possible defects or failures.
3. ANALYSE PHASE:
Six Sigma aims to define the causes of defects, measure those defects, and
analyze them so that they can be reduced. Five specific types of analysis
help to promote the goals of the project. These are source analysis, process
analysis, data analysis, resource analysis, and communication analysis.
The proper procedure is the one that wor ks best for your team, provided
that the result is successful. Analysis helps to reduce the defects.
4. IMPROVE PHASE:
If the project team does a thorough job in the root causation phase of
Analysis, the Improve phase of DMAIC can be quick, easy, and satisfy ing
work. The objective of Improve phase is to identify improvement
breakthroughs, identity high gain alternatives, the select preferred
approach, design the future state, determine the new sigma level, perform
Cost/benefit analysis, design dashboard/score cards, and create a
preliminary implementation plan.

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45 5. CONTROL PHASE:
The last stage or phase of DMAIC is control, which ensures that the
processes continue to work well, produce desired output results, and
maintain quality levels. There are four specific aspects of control i.e.
quality control, standardization, control methods and alternative, and
responding to defects. The project team determines how to technically
control the newly improved process and creates a response plan to ensure
the new process m aintains the improved sigma performance.
Meaning:
ISO is the International Organisation for standardization, located in
Switzerland. It has been established to develop common international
standards world wide. The term ISO 9000 refers to a set of quality
management standards. Currently, ISO 9000 is supported by national
standards bodies from nearly 150 countries including India. ISO currently
includes ISO 9000, ISO 9001, ISO 9002, ISO 9003, and ISO 9004. T hese
five series apply to a group of products or services and are not specific to a
product or service.
ISO 9000 is essentially a mark of quality assurance. The purpose of ISO is
to facilitate international trade by providing a single set of standards that
people worldwide would recognize and respect. It is to be noted that there
is no compulsion to obtain ISO certification and use ISO 9000 standards,
except in some cases where governments or regulatory authorities impose
them for public security reasons, o r where they are required in contractual
terms. However, the demand for these standards has been increasing in the
global markets, and avoiding them will soon become impossible. It is also
be noted that the ISO registration does not automatically extend to other
plants of a company, even if the same product or the same service is been
offered.
4.5 PROCEDURE TO OBTAIN ISO 9000
The following is the procedure to obtain ISO 9000 certification -
a) Preliminary Investigation:
The Company wishing to obtain ISO 9000 certification should first
conduct self -evaluation to determine its quality control infrastructure. This
work can be entrusted to a team of specialists working with the firm the
company can appoint an ISO steering team to evaluate the existing quality
procedures prevailing within the firm.
b) Submission of application:
Exporters can apply on the prescribed proforma in triplicate to the nearest
regional office of BIS along with the prescribed non -refundable 4.4 INTERNATIONAL STANDARDS ORGANISATION
(ISO 9000)
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46 application fee. The Company has to give informati on about the name,
location, and structure of the company, size of the business, range of
products, type of manufacturing process, name of products, etc.
c) Audit of the quality manual:
The existing quality manual is audited to determine how it compares w ith
the twenty elements of the ISO 9000 standard. A report is prepared on the
findings. Deficiencies, if any are corrected and the manual is resubmitted
for approval by the auditing body the quality manual would provide
guidelines to the employees of the f irm to maintain quality standards.
d) Selection of Registrar:
A registrar is an independent body with knowledge, skills, and experience
to evaluate a company's quality system. Registrars are approved and
certified by accreditors. The company should make a n application to the
accredited agency along with necessary documents which include quality
manual undertaking to pay the required fee etc.
e) Pre -assessment meeting:
The company representative would hold a pre -assessment meeting with
the registrar of the agency. Pre -inspection meetings may look for
sufficient documents as per the standards, implementation of the
documented procedure, and whether implementation is effective.
f) Preliminary visit:
The accredited agency, normally, arranges for a preliminary visit to the
firm and notifies the company of any significant omission or deviations
from the prescribed requirements, so that any suitable modification or
changes can be made before the assessment visit.
g) Actual Assessment visit:
The actual assessment visit is a practical evaluation to check that the
company's systems are functioning effectively. The assessment team from
the BIS will visit the firm to assessthe firm's compliance with the
procedures as mentioned in the quality manual. The assessment wil l go
through the opening meeting, conducting assessment, closing meeting, and
presenting the report.
h) Issue of certificate:
The assessment team should ensure whether the company has complied
with the ISO 9000 standard. Verbal feedback is given to the co mpany at
the time of assessment. The assessment team, if satisfied will submit a
favorable report to the registration board. When the registration board
approves the registration, the registrar issues a certificate that enables the
company to use ISO 9000 mark.
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47 Check Your Progress
1. Define the following terms:
a. Six Sigma
b. TQM
2. Enlist the steps in the Six Sigma process.
3. “Total quality management is a preventive approach and not a
corrective one”. Discuss.
4. Enlist the steps in the procedure to obtain ISO 9000 c ertification.
4.6 KAIZEN
The concept of Kaizen was made popular by Masaaki Imai in his book
Kaizen: - The Key to Japan's competitive success. Kaizen in Japanese
means 'change (kai) for good (zen)'. Kaizen technique places emphasis on
continuous improvement in varied aspects of the organization such as
quality, corporate culture, safety, technology, process, productivity, and
leadership. Kaizen applies not only to manufacturing units but also service
organizations as well as non -profit organizations.
Definit ion: - According to Sumuel Kho," Kaizen is a programme, a
philosophy and a strategy to improve quality of goods and services of an
organization".
4.6.1 Kaizen Process:
The following are the steps in the Kaizen process
a) Define the problem:
Kaizen is of u tility only when, at the initial stage, the problem is correctly
defined. When defining the problem we often notice a performance gap. It
means there is a difference between the ideal situation and the current
level of performance. In the process of defini ng the problem, we may
notice a deviation in performance.
b) Document the current situation:
The management must analyze the current situation in terms of
organization structure, Superior -Subordinate relationships, employee
selection procedures, training policies and practices, the production
facilities, corporate culture, technology, production process, and so on. A
proper analysis of the current situation may enable the management to
have a re -look at the causes of the problem. To solve the problem, it i s
important to correctly assess the current situation.

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48 c) To find the root cause:
Kaizen is built on the premise that it is vital to locate the root cause to
rightly solve the problem. Root cause analysis is the central theme of
Kaizen. Once the cause o f the problem is identified, under Kaizen, it is not
accepted instantly but several efforts are made to confirm that the cause
thus established is the real one. Root cause analysis uses problem -solving
techniques.
d) Define measurement Targets:
There is a need to define measurement targets at which the outcomes or
results can be compared. For example, the measurement target for
complaints of the customer can be stated as Reduction in customer.
Customers from the current level of 60 per month to 15 in the f irst month
of the implementation and finally to near zero at the end of three month
period.
e) Brainstorm Solutions to the problem:
The management needs to generate ideas to develop an effective solution
to the problem. As far as possible, multiple soluti ons need to be generated.
This can be done through various techniques i.e. obtaining suggestions
from the employees, analysis of solutions for a similar problem and
adopted by other organizations, organizing brainstorming sessions
involving representatives of the management and the employees, etc. The
knowledgeable people call to find the solution.
f) Develop Kaizen plan:
There is a need to prepare a Kaizen plan to bring continuous improvement
in the organization at all levels and in all departments. Kaize n plan
includes the areas or activities, responsible persons, period, process, and
the number of funds that can be utilized for improvements during the plan
period, etc.
g) Implement plan:
Once the solution is selected, and the plan is prepared to impleme nt the
solution, the management needs to implement the solution.
Implementation of the solution would involve i.e. arrangement of
resources, directing the employees, and motivating the employees.
h) Measurement of outcomes:
The management must measure the outcomes of the solution. The actual
outcome needs to be recorded and compared against the set targets. The
comparison is required to find out whether the organization is on the right
track to achieve Kaizen success.
i) Review:
Regular review of the imple mentation of the measures needs to be done.
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49 solved. The review will indicate that implementation was so done that it
solved the problem in totality. The results can be found out becau se of the
organizational goals.
j) To establish a new standard:
A standard is a specification by which results are measured, when the
problem is solved and the system is working well, the next step is to
establish a new standard. Once the problem is solved or the desired
objective is achieved, the new standard will deliver the expected results.
Service quality is understood in terms of the satisfaction that the customer
derives and whether it is in keeping with the service desi red. Service
quality management is undertaken to improve the quality of services
continue to enhance customer satisfaction and loyalty. It is to be noted that
service firms must consider the trade -off between incremental costs
involved in service quality i mprovement and incremental revenues. It
makes no business sense to improve the quality dimensions when the
customers are not willing to pay extra for the added quality dimensions.
Definition:
Service quality management refers to the monitoring and mainten ance of
end-to-end Services for specific customers or classes of customers.
4.7.1 Importance of Service Quality Management (SQM)
The importance of Service quality management is as follows
a) Customer Satisfaction:
Service quality management leads to impro vement in the quality of
services. Therefore, Service quality management leads to customer
satisfaction. Customer satisfaction takes place when service performance
meets customer expectations. At times, service quality management may
lead to customers' del ight. Customer delight takes place when service
performance is much more than customer expectation. Service providers
prosper on the continued support of customers.
b) Earning goodwill:
Service quality management offering high -quality service earns goodwi ll
in the market. They retain a competitive advantage in the marketplace.
Goodwill is not earned overnight but over a long period. These SQM's
offer consistently high -quality service which ensures consumer loyalty.
c) Efficiency:
Efficiency is the ratio o f returns to costs. A service organization would be
more efficient when it gets higher returns at lower costs than before.
Service quality management helps to reduce internal costs, and at the same 4.7 SERVICE QUALITY MANAGEMENT
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50 time, the organization is likely to get a higher return du e to the efforts of
trained and motivated employees.
d) Premium price:
Customers looking for reliable and satisfactory service are prepared to pay
a higher price provided the quality of service is as per their expectations.
In services like medical, trave l and tourism, entertainment, etc. customers
want better service and show readiness to pay the premium price.
e) Corporate Image:
Service quality management helps to improve the image of the
organization. Due to good quality services, the organization may get
higher performance, on account of higher performance,the image of the
organization improves in the mind of various stakeholders i.e. customers,
employees, shareholders, and others.
f) Commitment of top management:
Service quality must be based on act ive support, involvement, and
commitment of top management to accomplish specific goals. Top
management must not restrict its prosperity in terms of profits but must
also give equal importance to service performance to keep the customers
loyal to the busin ess.
g) Economies of Scale:
Service quality management may also generate economies of scale. The
service organization may adopt the latest technology for its operations.
The use of technology reduces the need for more manpower as it expands.
Therefore, th e service firm may get economies of large -scale operation.
h) Self -Service:
Service quality management helps to make service transactions prompt,
convenient, and accurate with the help of advanced technology. Because
of the use of advanced technology cust omers have preferred self -service.
For example, ATMs of banks, automatic vending machines at railway
stations, online purchase of tickets, and hotel booking. They make service
transactions prompt, convenient, and accurate.
i) Expansion of business:
Servic e quality management facilitates the expansion of business. Due to
higher performance, and corporate image, a service organization can enter
into new markets. This means a service organization can expand from
local level to regional level to national level and national level to
international level.
4.7.2 SERVQUAL Model :
The Service Quality Model or SERVQUAL Model was developed and
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51 Parasuraman, and Leonard Berry in 1988. Its purpose is to m easure the
service quality experienced by customers.
Marketing of services is more challenging than the marketing of goods. As
services are intangible they cannot be seen or touched. They can only be
felt or experienced by the customers. So to measure the performance/
quality of services is subjective and not easily quantifiable.
This model is a qualitative analysis. It finds out the shortcomings or
weaknesses in the performance of services provided by the supplier.
In that sense, it is also called ‘GAP Analysis’. It compares the expected
service quality and the service quality that has been experienced.
Thus the model helps to compare the expectations of the customers and
the satisfaction the customers have experienced after getting the service
performa nce. If there is a difference in quality that is shown in the
difference (the gap) between what was expected and what was experience
the organization can take certain corrective measures to improve the
service performance.
While studying and analyzing the performance of service quality, it was
found out that the following ten dimensions of service quality are
considered important service quality and they are reliability,
responsiveness, competence, access, courtesy, communication credibility,
security, kno wing the customer, and tangibles such as the appearance of
the staff and office.
So this model is certainly useful to organizations dealing in goods and
services to survive in a competitive environment. They are to be conscious
about the service quality p rovided by them to gain consumer satisfaction.
4.7.3 Measures to improve service quality :
Products are tangible and so they have standard specifications and so
measuring the quality of products is rather easier whereas services are
intangible so measurin g the quality of services is rather a challenging task.
However, it is important to measure the service quality provided by the
organizations to make decisions on measures to improve service quality
and thereby consumer satisfaction.
The following are the measures to improve service quality -
1. The first step is to measure service quality as it is hard to improve that
which is not measured.
2. The second step is to identify gaps between the customer’s
expectations of service quality and the service provider’s desired level
of performance.
3. To understand the customer expectations, efforts should be made to
observe and interact with customers by conducting customer visits &
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52 4. After knowing the customer expectations, the organization should
create service quality standards.
5. Employees should be trained in performing the services.
6. The management to observe how services are being performed by the
staff.
7. The organization should recruit skilled and knowledgeable staff and
make efforts to retain and motivate t hem.
8. There have to be effective & prompt feedback from customers to know
their satisfaction levels.
4.8 SUMMARY
Total Quality management is a strategic approach to produce the best
possible product and service through constant innovation and timely
actio n. It emphasizes prevention rather than rectification. Total quality
management focused on consumer, process, employees, quality,
productivity, techniques, etc.
Six Sigma is a set of tools that a company adopts to achieve dramatic
improvement in its profit s. The uses of these tools cut down costs and
remove inefficiencies in production or use of resources. Six Sigma helps a
company to re -tool and re -create itself to prevent problems and defects.
Six Sigma helps to solve a problem, reduced process variation, uses
factual data, improvesthe market image, customer focus, organizational
commitment, better approach, and continuous improvement. The six
Sigma approach can be explained with the help of the DMAIC (Define,
Measure, Analyse, Improve, and Control) method ology.
The quality standard recognized at the global level is called ISO 9000. It
provides common standards of products and services worldwide. ISO
9000 is essentially a mark of quality assurance. It has a good amount of
procedures to obtain ISO 9000 certi fication.
Kaizen emphasizes process -oriented thinking as opposed to result -oriented
thinking. The ultimate goal should be that not a day should pass without
some kind of improvement made somewhere in the organization. A small
improvement on a continuous pr ocess is the bottom line of Kaizen.
Service quality management is of great importance because it ensures
repeat visits from clients. There appears to be some agreement that the
important practices are unavoidable to ensure better service quality
management i.e. customer satisfaction, Earning goodwill, efficiency,
premium price, corporate image, the commitment of top management,
economies of scale, self -service, expansion of business, etc.

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53 4.9 EXERCISE
Multiple Choice Questions
1. ___________ It is a wide term that is concerned with an overall
improvement of the system,techniques, and staff of the organization.
a) Total Quality Management b) Quality Controlc) Quality
Management d) Cost of Quality
2. __________ follows a Zero Defect Approach
a) Total Quality Management b) Quality Control c) Quality
Management d) Cost of Quality
3. ____________ means to work together.
a) Synergy b) Team Work c) Grouping d) Grapevine
4_____________ is a set of tools, techniques, and strategies designed for
process improvement
a) Total Quality Management b )Six Sigma c) Quality Circles d)
Quality management
5. _____________ attempts to improve the quality of process output by
identifying and removing the cause of defects or errors
a) Total Quality Management b ) Six Sigma c) Quality Circles d)
Quality management
6. The First step of Six Sigma is _______________
a) Measure Phase b ) Define Phase c) Analyse Phase d) Control Phase
7. The Last step of Six Sigma is _______________
a) Measure Phase b ) Define Phase c) Analyse Phase d) Control Phase
8. ___________ emphasis on continuous improvement in varied aspects
ofthe organization such as quality, corporate culture, safety,technology,
process, productivity, and leadership
a) TQM b ) KAIZEN c) Quality Management d) Quality Circles
9. ____________ finds out the shortcomings or weaknesses in the
performance of services provided by the supplier.
a) SERVQUAL Model b) KAIZEN c) SQM ) Six Sigma


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54 Theory Questions
1. Define TQM. Explain the main features of TQM
2. Define TQM. What is the Import ance of TQM
3. Define Six Sigma. What are the features of Six Sigma?
4. Discuss the steps or phases of Six Sigma.
5. Explain the procedure of ISO 9000.
6. Explain the process of Kaizen.
7. Discuss the importance of Service Quality Management.
8. Write short notes:
a. TQM
b. Six Sigma
c. ISO 9000
d. Kaizen
e. Service Quality Management



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55 5
INDIAN FINANCIAL SYSTEM - I
Unit Structure
5.0 Objectives
5.1 Introduction
5.2 Financial System
5.3 Indian Financial System
5.4 Components of Indian Financial System
5.5 Financial Markets
5.6 Securities Markets
5.7 Difference between Primary and Sec ondary Market
5.8 Role of Financial Markets
5.9 Depositories & their Role
5.10 Summary
5.11 Questions
5.0 OBJECTIVES
After studying the unit the students will able to:
 Know the meaning of the Financial System.
 Explain the structure of the Indian Fina ncial System.
 Understand the components of the Indian Financial System.
 Understand the classification of the Financial Market.
 Discuss the types of Securities Markets

5.1 INTRODUCTION
The economic development of a nation is reflected by the progress of th e
various economic units, broadly classified into the corporate sector,
government, and household sector. There are areas or people with surplus
funds and there are those with a deficit. A financial system or financial
sector functions as an intermediary a nd facilitates the flow of funds from
the areas of surplus to the areas of deficit. A Financial System is a
composition of various institutions, markets, regulations and laws,
practices, money managers, analysts, transactions, and claims and
liabilities.
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56 The financial system comprises a set of subsystems of financial
institutions, financial markets, financial instruments, and services that
helps in the formation of capital. It provides a mechanism by which
savings are transformed into investment.

5.2 FINANCIAL SYSTEM
The word "system", in the term "financial system", implies a set of
complex and closely connected or interlinked institutions, agents,
practices, markets, transactions, claims, and liabilities in the economy. The
financial system is concerned about money, credit, and finance -the three
terms are intimately related yet are somewhat different from each other.
Indian financial system consists of a financial market, financial
instruments, and financial intermediation.
A financial system functions as an intermediary between savers and
investors. It facilitates the flow of funds from the areas of surplus to the
areas of deficit. It is concerned about money, credit, and finance. These
three parts are very closely interrelated with each other and depen d on
each other.
5.2.1 FUNCTIONS OF FINANCIAL SYSTEM
Following are the main functions:
1. To mobilize savings and channelize them into productive activities.
2. To make provision of money and monetary assets for the production of
goods and services.
3. To provide a payment system for the exchange of goods and services.
4. To facilitate pooling of funds for undertaking large -scale enterprises.
5. To provide a mechanism for temporal transferor resources.
5.3 INDIAN FINANCIAL SYS TEM
 INTRODUCTION TO INDIAN FINANCIAL SYSTEM ( IFS)
The IFS has experienced impressive growth in the post -1950 era. Until the
early 1990s, the role of the financial system in India was primarily
restricted to the function of channeling resources from the surplus to
deficit sectors. As a result of the r eforms and initiatives taken by the munotes.in

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57 Government and the Regulators, the market structure has been refined and
modernized. This is visible from the following:
 Introduction of a variety of schemes and instruments for mobilizing
savings.
 The emergence of a wid e variety of financial institutions to provide a
variety of services.
 Expansion in the network of commercial banks and operations of
financial institutions.
 The remarkable growth in the primary and secondary segments of the
capital market.
 Introduction of new intermediaries and new instruments in the capital
market.
 Nationalization of banks, the establishment of UTI, establishment of
term lending institutions, institution for agricultural finance, an
institution for housing finance, growth of mutual fund i ndustry,
venture capital institutions, etc.
Financial structure refers to the shape, components, and order in the
financial system. The Indian financial system can be broadly classified
into:
1. Formal (organized) Financial System and
2. Informal (unorganized) Financial System.
The formal financial system comprises of Ministry of Finance, RBI, SEBI,
and other regulatory bodies. The informal financial system consists of
individual money lenders, groups of persons operating as funds or
associations, partnership f irms consisting of local brokers, pawnbrokers,
and non -banking financial intermediaries such as finance, investment, and
chit fund companies.
5.4 COMPONENTS OF INDIAN FINANCIAL SYSTEM
Components of Formal Financial System:
The formal financial system compr ises financial institutions, financial
markets, financial instruments, and financial services. These constituents
or components of the Indian financial system may be briefly discussed as
below:


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58 COMPONENTS OF FINANCIAL SYSTEM

Indian financial system is a broad term that includes the following
components:
1. Finan cial markets
2. Financial intermediaries
3. Financial instruments
4. Financial Services
1. Financial Markets:
A financial market is a market in which financial assets are created or
transferred. It provides funds for undertaking business activities.
Follow ing is the structure of the financial markets








Money Market (Short term securities) Capital Market (Long term securities) Industrial Securities Market Gilt Edged Market (Government Primary Ma rket (New issue) Secondary Market (Stock Exchange) munotes.in

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59 a) Money market:
The money market deals with short -term funds. There are two sectors in
the money market i.e. organized sector and unorganized sector. RBI has
control over the organized sector whereas it has no control over the
unorganized sector. The money market is a wholesale debt market for low -
risk, highly liquid, and short -term instruments. Funds are available in this
market for periods ranging from a single day up to a year. This market is
domin ated mostly by the government, banks, and financial institutions.
b) Capital Market:
A capital market is a market for long -term debt and equity shares. The
transactions taking place in this market are generally more than a year. It
includes the industrial securities market which is classified into primary
market and secondary market. The primary market deals with a new issue
and the secondary market deals with the trading of securities i.e. stock
exchanges.
2. Financial Intermediaries:
Financial intermediar ies are banks, financial institutions, and brokers.
When the borrower of the funds approaches the financial market to raise
funds, he needs to have full details about the issue, issuer and the security
should be passed on. There should be a proper channel within the financial
system to ensure such transfer. To serve this purpose, the role of financial
intermediaries is important. These financial intermediaries include
investment bankers, underwriters, stock exchanges, registrars,
depositories, custodians, m utual funds, portfolio managers, primary
dealers, etc.
3. Financial instruments:
Financial instruments include money market instruments and capital
market instruments. The financial instruments in the money market are
generally for the short term i.e. up t o one year. Some of the important
money market instruments are Notice Money, Term Money, Treasury
Bills, Certificate of Deposit, Commercial Papers, etc. Whereas the capital
market generally consists of financial instruments of the long term i.e.
more than one year. Some of the important financial instruments in the
capital market are equity shares, preference shares, debentures, bonds,
security deposits, treasury bills, etc.
4. Financial services:
The financial services sector provides financial services t o people and
corporations. This segment of the economy is made up of a variety of
financial firms including banks, investment houses, lenders, finance
companies, real estate brokers, and insurance companies. As noted above,
the financial services industry is probably the most important sector of the
economy, leading the world in terms of earnings and equity market
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60 5.5 FINANCIAL MARKETS
The financial market is an important component of the Indian Financial
System. Efficient financial markets are essential for speedy economic
development. The vibrant financial market enhances the efficiency of
capital formation. It facilitates the flow of savings into investment.
Financial markets bridge one set of financial intermediaries with another
set of p layers. Financial markets are the backbone of the economy. This is
because they provide monetary support for the growth of the economy.
The growth of the financial markets is the barometer of the growth of a
country’s economy.
Financial market deals in fin ancial securities (or financial instruments) and
financial services. Financial markets are the centers or arrangements that
provide facilities for buying and selling of financial claims and services.
These are the markets in which money, as well as monetar y claims, is
traded in.
Financial markets exist wherever financial transactions take place.
Financial transactions include the issue of equity stock by a company,
purchase of bonds in the secondary market, a deposit of money in a bank
account, transfer of funds from a current account to a savings account, etc.
The participants in the financial markets are corporations, financial
institutions, individuals, and the government. These participants trade in
financial products in these markets. They trade either directly or through
brokers and dealers.
In short, financial markets are markets that deal in financial assets and
credit instruments.
5.5.1 FUNCTIONS OF FINANCIAL MARKETS:
The main functions of financial markets are outlined as below:
a. To facilitate the creation and allocation of credit and liquidity.
b. To serve as intermediaries for mobilization of savings.
c. To help in the process of balanced economic growth.
d. To provide financial convenience.
e. To provide information and facilitate transactions at a low cost.
f. To cater to the various credit needs of the business
organizations.


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61 5.5.2 CLASSIFICATION OF FINANCIAL MARKETS:
There are different ways of classifying financial markets. There are mainly
five ways of classifying financial markets.
a. Classification bas ed on the type of financial claim:
On this basis, financial markets may be classified into debt markets and
equity markets.
1. Debt market:
This is the financial market for fixed claims like debt instruments.
2. Equity market:
This is the financial marke t for residual claims, i.e., equity instruments.
b. Classification based on the maturity of claims:
On this basis, financial markets may be classified into money markets and
capital markets.
1. Money market:
A market where short -term funds are borrowed a nd lend is called the
money market. It deals in short -term monetary assets with a maturity
period of one year or less. Liquid funds as well as highly liquid securities
are traded in the money market. Examples of money markets are Treasury
bill market, call money market, commercial bill market, etc. The main
participants in this market are banks, financial institutions, and the
government. In short, a money market is a place where the demand for and
supply of short -term funds are met.
2. Capital market:
The capital market is the market for long -term funds. This market deals in
long-term claims, securities, and stocks with a maturity period of more
than one year. It is the market from where productive capital is raised and
made available for industrial purpos es. The stock market, the government
bond market and the derivatives market are examples of the capital
market. In short, the capital market deals with long -term debt and stock.
c. Classification based on the seasoning of claim :
On this basis, financial m arkets are classified into primary markets and
secondary markets.
1. Primary market:
Primary markets are those markets that deal in the new securities.
Therefore, they are also known as new issue markets. These are markets
where securities are issued for the first time. In other words, these are the
markets for the securities issued directly by the companies. The primary
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62 units. In short, the primary market is a market for raising f resh capital in
the form of shares and debentures.
2. Secondary market:
Secondary markets are those markets that deal in existing securities.
Existing securities are those securities that have already been issued and
are already outstanding. The secondary market consists of stock
exchanges. Stock exchanges are self -regulatory bodies under the overall
regulatory purview of the Govt. /SEBI.
d. Classification based on structure or arrangements :
On this basis, financial markets can be classified into organize d markets
and unorganized markets.
1. Organised markets:
These are financial markets in which financial transactions take place
within well -established exchanges or in a systematic and orderly structure.
2. Unorganised markets:
These are financial market s in which financial transactions take place
outside the well -established exchange or without systematic and orderly
structure or arrangements.
e. Classification based on the timing of delivery :
On this basis, financial markets may be classified into cash /spot markets
and forward / futures markets.
1. Cash / Spot market:
This is the market where the buying and selling of commodities happen or
stocks are sold for cash and delivered immediately after the purchase or
sale of commodities or securities.
2. For ward/Future market:
This is the market where participants buy and sell stocks/commodities,
contracts and the delivery of commodities or securities occurs at a pre -
determined time in the future.
3. Other types of financial market:
Apart from the above, th ere are some other types of financial markets.
They are the foreign exchange market and derivatives market.
4. Foreign exchange market:
A foreign exchange market is simply defined as a market in which one
country’s currency is traded for another country’s currency. It is a market
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63 5. Derivatives market:
Derivatives are the most modern financial instruments in hedging risk.
The individuals and firms who wish to avoid or reduce risk can deal with
the others wh o are willing to accept the risk for a price. A commonplace
where such transactions take place is called the derivative market. It is a
market in which derivatives are traded. In short, it is a market for
derivatives. The important types of derivatives are forwards, futures,
options, swaps, etc.
CHECK YOUR PROGRESS
1. Fill in the blanks
a. Primary Markets are also known as --------------------- markets.
b. Forwards, futures, options, swap, etc. are the examples of -------------
-----market.
c. A market for the purchase a nd sale of foreign currencies is known as
----------------------------- market.
d. the market where the buying and selling of commodities happen for
cash is called as -------------- market.
e. When the financial transactions take in the systematic and orderly
structure it means it is a ----------------- market.
2. Draw the figure explaining the components of the Indian Financial
System.
3. Define the following terms:
a. Forward market
b. Unorganized market
c. Money market
d. Capital market
e. Primary market
f. Secondary market
g. Financial s ystem.
5.6 SECURITIES MARKETS
A Securities market is an exchange where sale and purchase transactions
of securities are conducted based on demand and supply. A well -
functioning securities market should be able to provide timely and
accurate information on past transactions, liquidity, low transaction costs
(internal efficiency), and securities prices that rapidly adjusted to all
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64 There are two levels of securities markets Primary and secondary market:
5.6.1 Prima ry Market
Primary Market is the market for new securities issues and is facilitated by
underwriting groups. The companies sell their securities to the public
directly to the investors through the underwriters (normally investment
banks for stock and bond issuance). When the firm is issuing shares for the
very first time, it is called Initial Public Offering (IPO). New shares issued
by firms whose shares are already trading in the market are called
seasoned or secondary issues. The issuing company receives cash from
the sale and uses it to expand or fund the operations. After the initial sale,
the securities trading will be conducted on the secondary market.
The primary market is the part of the capital market that deals with issuing
of new securities. Comp anies, governments, or public sector institutions
can obtain funds through the sale of a new stock or bond issues through
the primary market. This is typically done through an investment bank or
finance syndicate of securities dealers.
The process of selli ng new issues to investors is called underwriting. In
the case of a new stock issue, this sale is an Initial Public Offering (IPO).
Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus. P rimary markets create
long-term instruments through which corporate entities borrow from the
capital market.
Once issued the securities typically trade on a secondary market such as a
stock exchange, bond market, or derivatives exchange.
Features :
Features of primary markets are:
1. This is the market for new long -term equity capital. The primary
market is the market where the securities are sold for the first time.
Therefore it is also called the new issue market (NIM).
2. In a primary issue, the securities are issued by the company directly to
investors.
3. The company receives the money and issues new security certificates
to the investors.
4. Primary issues are used by companies to set up a new business or for
expanding or modernizing the existing business.
5. The prim ary market performs the crucial function of facilitating capital
formation in the economy.
6. The new issue market does not include certain other sources of new
long-term external finance, such as loans from financial institutions.
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65 converting private capital into public capital; this is known as "going
public
5.6.2 INITIAL PUBLIC OFFER ( IPO )
The IPO (Initial Public Offering) process is the process through which a
private company issues new and or e xisting securities to the public for the
first time.
Private companies decide to convert themselves into Public Limited
Companies to raise a huge amount of capital in exchange for securities. So
to offer its shares to the public, it has to go through the process of IPO.
The IPO process is quite complicated. The entire process of IPO is
regulated by the Securities and Exchange Board of India. The following
are the steps involved in the IPO process.
1. Appointment of an investment bank:
A company appoints a te am of underwriters or investment banks to start
the process of IPO. They are the specialized agencies to market the
securities to the public. They study the financial position of the company
and make decisions on the amount that will be raised and the secu rities
that will be issued. They are the managers of the issue of securities and do
not share the risks involved in the marketing of securities.
2. Register with SEBI :
The company has to submit a registration statement to SEBI, which
includes a detailed re port of its financial position and business plans. It has
to fulfill all the requirements and satisfy all rules and regulations.
3. Preparation of the Prospectus :
The companies with the help of the underwriters have to prepare the
prospectus giving all the details of the company & its plans and the
expected share price range. The prospectus is meant for prospective
investors who would be interested in buying the stock.
4. The Roadshow :
Once the prospectus is ready, underwriters and company officials plan
countrywide roadshows for promoting the company’s IPO among selected
few private buyers and also to get the idea about the response of the
prospective investors.
5. SEBI’s Approval :
Once SEBI is satisfied with the registration statement, it gives a green
signal to the IPO and date to be fixed for the same. Sometimes, it asks for
certain changes in the prospectus before giving its approval.

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66 6. Selection of a stock exchange/s –
The Company needs to select a stock exchange/s where it intends to sell
its shares a nd get listed.
7. Deciding on Price Band and number of share to be issued :
After the SEBI approval, the company, with assistance from the
underwriters decides on the price band of the shares and also decides the
number of shares to be sold. The shares can b e issued with the help of two
methods - 1) Fixed Price IPO - In a Fixed Price issue, the company
decides the price of the share issue and the number of shares being sold. 2)
Book Building IPO - A Book building issue helps the company discover
the price of the issue. The company decides a price band and it gives the
investor an option to choose the price at which he/she wishes to bid for the
company shares.
8. Available to Public for Purchase :
On the dates mentioned in the prospectus, the shares are made ava ilable to
Public Investors fill -up the IPO form and if it is a book building IPO,
specify the price at which they wish to make the purchase and submit the
application.
9. Determination of Issue Price and Share Allotment :
Once the stipulated period for apply ing for IPO is over, the company, with
the help of underwriting banks, determines the price at which shares are to
be allotted to the prospective investors. The price would be directly
determined by the demand and the bid price quoted by investors. Once th e
price is finalized, shares are allotted to investors based on the bid amounts
and the shares available. In case of over -subscribed issues, shares are not
allotted to all applicants.
10. Listing of shares :
The last step is the listing of shares on the stoc k exchanges.
5.6.3 Secondary Market:
The secondary market, also known as the aftermarket, is the market where
the trading of the previously issued securities is conducted. On a
secondary market, an investor buys securities from another investor
instead o f the issuer. It is important that the secondary market provides
liquidity and therefore provides continuous information about the market
price of the securities.
Secondary markets are mainly organized in two ways. One is to form a
centralized and organize d exchange where all buyers and sellers (or their
representative agents) meet and conduct trading.
The more investors participate in a market, the greater the centralization of
that market, and the more liquid the market. Some examples of this form
of sec ondary markets are New York Stock Exchange (NYSE) and munotes.in

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67 American Stock Exchange (AMEX). The other way is the Over -the-
counter (OTC) market which a secondary market where securities are
traded directly between two parties. Trading occurs via dealers who carry
inventories of securities and contact each other by computer, telephone, or
other electronic networks instead of a physical trading floor. Over -the-
counter dealers quote a bid price at which they would buy, and an ask
price at which they would sell. An ex ample of an over -the-counter
securities market is the National Association of Securities Dealers
Automated Quotations System (Nasdaq).
The secondary market is the financial market in which previously issued
financial instruments such as stock, bonds, optio ns, and futures are bought
and sold.
The term "secondary market" is also used to refer to the market for any
used goods or assets, or alternative use for an existing product or asset
where the customer base is the second market (for example, corn has been
traditionally used primarily for food production and feedstock, but a
"second" or "third" market has developed for use in ethanol production).
With primary issuances of securities or financial instruments, or the
primary market, investors purchase these se curities directly from issuers
such as corporations issuing shares in an IPO or private placement, or
directly from the federal government in the case of treasuries. After the
initial issuance, investors can purchase from other investors in the
secondary m arket.
Function :
In the secondary market, securities are sold by and transferred from one
investor or speculator to another. It is therefore important that the
secondary market be highly liquid (originally, the only way to create this
liquidity was for inv estors and speculators to meet at a fixed place
regularly; this is how stock exchanges originated, see History of the Stock
Exchange). As a general rule, the greater the number of investors that
participate in a given marketplace, and the greater the centr alization of that
marketplace, the more liquid the market.
5.7 DIFFERENCE BETWEEN PRIMARY AND
SECONDARY MARKET
Primary markets are those where securities are offered to the public in the
form of subscriptions to raise money. On the other hand, the seconda ry
market refers to the market where the trading of already existing securities
take place. The secondary market is often referred to as a dealer market or
an auction market. Examples of an auction market are the stock exchange
whereas an OTC or over the c ounter exemplifies a dealer market. In a
primary market, the securities, stocks, or bonds are bought directly from
the company issuing all of the above. These are usually bought at a "par
value". In the secondary market, the existing securities, bonds, or stocks
are traded again. For instance, if an individual had purchased bonds or any munotes.in

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68 other investment instruments from the primary market a year back and the
individual now wants to avail of the principal amount the bonds may be
sold off in the secondary mar ket.
In the event when the price of the bonds rises, the individual intending to
dispose of the bonds needs to do it at a discounted rate. On the other hand,
if the price of bonds increases, the individual selling the shares will be
benefited and may sell it at a premium rate.
5.8 ROLE OF FINANCIAL MARKETS
The role of financial markets is as follows:
1. Capital formation:
The financial markets encourage capital formation in the country. The
financial markets mobilize savings of the households and the indu strial
concerns. Such savings are then invested for productive purposes. Thus,
savings and investments lead to capital formation in the country.
2. Economic Growth:
Financial markets facilitate the growth of the industrial sector, as well as
the other sec tors of the economy. The capital market makes it possible to
lend funds to various projects, both in the private sector as well as in the
public sector. The productive use of capital funds leads to economic
development in the country.
3. Development of Bac kward areas:
The financial markets provide funds for the projects in backward areas.
For instance, entrepreneurs can obtain funds by way of long -term loans,
debentures, shares, etc. for investment in backward areas. This facilitates
the economic developme nt of backward areas.
4. Greater employment:
Financial markets generate employment in the country:
Direct employment in the financial markets related activities such as stock
markets, banks, and financial institutions.
Indirect employment in all the sect ors of the economy because of the
funds provided for developmental projects.
5. Foreign Capital:
The financial markets generate foreign capital. Indian firms can generate
capital funds from overseas markets by way of bonds and other securities.
Such forei gn exchange funds are vital for the economic development of
the nation.
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69 6. Development of Stock Market:
Financial markets facilitate the development of stock markets. Several
investors invest in primary securities such as shares and debentures in the
secondary market. This facilitates the development of stock markets.
7. Development of Role of Financial institutions:
Financial institutions play an important role in financial markets, they are:
 Provides medium and long -term funds to various sectors.
 Refin ances the commercial banks.
 Rediscount the bills of commercial banks.
 Merchant banking services.
8. Investment opportunity :
Financial markets provide an excellent investment opportunity to the
members of the public. Due to financial markets, the public ha s alternative
sources of investment. The public can invest not only in bank deposits but
also in shares and debentures issued by public companies. Investors can
get handsome returns from stock markets if they invest wisely in blue -chip
companies.
9. Reviva l of sick units:
The financial markets facilitate the revival of several sick units in India,
the commercial and FIs provide financial assistance to viable sick units to
overcome their industrial sickness. The banks and FIs may also write off a
part of th e loan, or they re -schedule the loan, to offer payment flexibility
to the weak units, which in turn help the weak units to overcome financial -
industrial sickness.
10. Easy liquidity :
The secondary market makes it possible for the investors to sell off the ir
holdings in form of shares and debentures and convert them into liquid
cash. The commercial banks also allow investors to withdraw their
medium -term and long -term deposits, as and when they need funds,
subject to certain conditions.
5.9 DEPOSITORIES
Earlier shares were issued in the form of physical certificates that the
investor had to keep safe and then forward to the buyer once sold. This
process was highly time -consuming and gave rise to issues like fake
securities and bad deliveries. Because of all these problems and the
improvement in technology a new system of depositories and the
electronic mode of holding and transferring shares have come up.
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70 The electronic mode of holding and transferring shares is called the
dematerialization of securities. I t is a process by which the physical
certificates of an investor are taken up by the depositary and are destroyed
and an equivalent number of securities are credited in the depository
account of the investor. The depository acts as a bank. It accepts the
deposits of securities such as shares, debentures, bonds, and government
securities, in electronic form. Thus depositary holds the securities of
investors and provides services to them.
In India, two companies are acting as depositories and they are - 1)
National Securities Depository Ltd. (NSDL) and Central Depository
Service Ltd. (CDSL). The depositories provide their services to investors
through their agents called depository participants (DP). A DP can be a
bank, financial institution, a custodian, or a broker. Just as one opens a
bank account to avail of the services of a bank / an investor opens a
depository account with a depository participant to avail of depository
facilities.
The following are the functions/Role of Depository –
1. Dematerialization:
One of the primary functions of the depositary is to eliminate or
minimize the movement of physical securities in the market. This is
achieved through the dematerialization of securities.
2. Account Transfer:
The depository keeps records of all transfers resulting from the
settlement of trades and other transactions between various beneficial
owners by recording entries in the accounts of such beneficial owners
3. Transfer and Registration:
A transfer is the legal change of ownership of a security in the re cords
of the issuer. For affecting a transfer, certain legal steps have to be
taken like an endorsement, execution of a transfer instrument, and
payment of stamp duty.
4. Corporate Actions:
A depository may handle corporate actions in two ways. In the first
case, it merely provides information to the issuer about the persons
entitled to receive corporate benefits. In the other case, the depositary
itself takes the responsibility for the distribution of corporate benefits.
5. Pledge and Hypothecation:
Deposita ries allow the securities placed with them to be used as
collateral to secure loans and other credits.
6. Linkages with clearing system:
The depository has linkages with the clearing system attached to a
stock exchange that performs the functions of ascerta ining the pay in
(Sell) or payout (buy) of brokers who have traded on the stock
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71 5.10 SUMMARY

From the above discussion, the structure of the Indian Financial System
and its working is clear. The economic growth and development of any
country dep end upon a well -knit financial system. A financial system is a
set of complex and closely interlinked financial institutions, financial
markets, financial instruments, and services that facilitate the transfer of
funds. The financial system provides a mec hanism by which savings are
transformed into investments and it can be said that the financial system
plays a significant role in the economic growth of the country by
mobilizing surplus funds and utilizing them effectively for productive
purposes.
The Fin ancial System of any country consists of financial markets,
financial intermediation, and financial instruments or financial products. A
financial market is a market that facilitates the transfer of funds between
investors and borrowers. It deals in financ ial instruments like bills of
exchange, shares, debentures, bonds, etc. It provides security to dealings
in financial assets, liquidity to financial assets for investors, and ensures
low cost of transitions and information. It consists of two major segmen ts:
(a) Money Market; and (b) Capital Market. While the money market deals
in short -term credit, the capital market handles the medium -term and long -
term credit.
5.11 EXERCISE
Multiple Choice Questions
1. A ____________ functions as an intermediary betwee n savers and
investors
a) Financial System b) Agent c) Broker d) Investor
2. A ____________ is a market in which financial assets are created or
transferred
a) Financial Market b) Financial Services c) Labour Market d) Fruit
Market
3. In ___________ market Government Securities are delt with
a) Gilt Edged b) Capital c) Money d) Private
4. In ___________ market New and Fresh shares are traded
a) Primary b) Secondary c) Money d) Private
5. In ___________ market existing shares are traded
a) Primary b ) Secondary c) Money d) Private
6. ___________ market deals with short term securities
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72 7. ____________ is the market where the buying and selling of
commodities happen or stocks are sold for cash and delivered
immediately after the purchase or sale of commodities or securities
a) Forward/Future b) Swap c) Cash/Spot d) Derivatives
8. ___________ is the market where participants buy and sell
stocks/commodities, contracts and the delivery of commodities or
securit ies occurs at a pre -determined time in the future
a) Forward/Future b) Swap c) Cash/Spot d) Derivatives
9. In __________ market is which where one country’s currency is traded
for another country’s currency
a) Foreign Exchange b) Swap c) Cash/Spot d) Derivatives
10. ______________ process is the process through which a private
company issues new and or existing securities to the public for the
first time.
a) FPO b) MBO c) IPO d) FFO
11. The electronic mode of holding and transferring shares is call ed the
_____________ of securities.
a) Dematerialization b) Rematerialization c) Physical form d) E
holding
12. __________ holds the securities of investors and provides services to
them
a) Depositary b) SEBI c) RBI d) Companies
Theory Questions
1. Wha t is the financial system? Explain the structure of the Indian
financial system.
2. Distinguish between Primary Market and Secondary market.
3. Explain in detail the role of financial markets.
4. Explain the classification of the Financial Market.
5. What are the comp onents of the Indian financial System?
6. Write Short Notes;
a. Primary Market
b. Secondary Market
c. Role of Financial Market
d. Financial System
e. Financial Market
f. Role of Depositories

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73 6
INDIAN FINANCIAL SYS TEM - II
Unit Structure
6.0 Objectives
6.1 Introduction
6.2 Securities and Exchange Board of India (SEBI)
6.3 Stock Exchange
6.4 Bombay Stock Exchange (BSE)
6.5 Dematerialisation
6.6 Credit Rating Agencies (CRA)
6.7 Summary
6.8 Exercise
6.0 OBJECTIVES
After studying the unit the students will be able to:
 Explain the role, functions, and objectives of SEBI.
 Know about the Stock Exchange and its functions
 Discuss the concept of Dematerialization and its process.
 Understand the me aning of Credit Rating Agencies and their
functions and advantages.
 Know about CRISIL.
6.1 INTRODUCTION
In 1991, India opened its economy for outsiders. The globalization and
liberalization policies introduced by the government increased the volume
of bus iness in both the primary and secondary markets. As the securities
market started growing so also the number of malpractices in these
markets such as manipulation of security prices, price rigging, insider
trading, delay in the listing, delay in settlement , etc. It was necessary to
curb these malpractices and promote healthy capital markets. The
government felt the need to take measures for developing and regulating
the Indian Financial sector. As a result, various bodies came into
existence. Stock Exchang e, SEBI, and Credit Rating Agencies are the
fruits of these efforts.

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74 6.2 SECURITIES AND EXCHANGE BOARD OF
INDIA (SEBI)
The Securities and Exchange Board of India (frequently
abbreviated SEBI) is the regulator for the securities market in India. It was
established in the year 1988 and given statutory powers on 12 April 1992
through the SEBI Act, 1992 .
SEBI has its Headquarters are at the SEBI Bhavan, Bandra Kurla
Complex, Bandra East, Mumbai - 400051, and has Nort hern, Eastern,
Southern, and Western Regional Offices in New Delhi , Kolkata , Chennai ,
and Ahmedabad respectively and is planning to open offices at Guwahati,
Bhubaneswar, Patna, Kochi and Chandigarh in Financial Year 2013 -
2014. The SEBI is a vi tal component in improving the quality of the
financial markets in India, both by attracting foreign investors and
protecting Indian investors.
The SEBI is managed by its members, which consists of the following:
 The chairman is nominated by the Union Gov ernment of India.
 Two members, i.e. Officers from Union Finance Ministry.
 One member from The Reserve Bank of India.
 The remaining 5 members are nominated by the Union Government of
India out of them at least 3 shall be a whole -time member
6.2.1 REASONS FOR ESTABLISHMENT OF SEBI
With the growth in the dealings of stock markets, a lot of malpractices also
started in stock markets such as price rigging, ‘unofficial premium on a
new issue, and delay in delivery of shares, violation of rules and
regulations o f the stock exchange and listing requirements. Due to these
malpractices, the customers started losing confidence and faith in the stock
exchange. So the government of India decided to set up an agency or
regulatory body known as the Securities Exchange Bo ard of India (SEBI).
6.2.2 PURPOSE AND ROLE OF SEBI
SEBI was set up with the main purpose of keeping a check on
malpractices and protect the interest of investors. It was set up to meet the
needs of three groups.
1. Issuers:
For issuers, it provides a marketp lace in which they can raise finance
fairly and easily. With the achievement of this objective, it becomes easy
for the New Companies to enter the Financial Markets.

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75 2. Investors:
For investors, it provides protection and supply of accurate and correct
information. This helps to maintain the trust and Confidence among the
Investors which tends to more and More money inflow in the market
which helps in the growth and development of the economy.
3. Intermediaries:
For intermediaries, it provides a competitive pr ofessional market which
facilitates the increase in efficiency of the Intermediaries.
6.2.3 OBJECTIVES OF SEBI
The overall objectives of SEBI are to protect the interest of investors and
to promote the development of the stock exchange and regulate the
activities of the stock market.
The objectives of SEBI are:
1. To regulate the activities of the stock exchange.
2. To protect the rights of investors and ensuring the safety of their
investment.
3. To prevent fraud and malpractices by having a balance between self -
regulation of business and its statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as
brokers, underwriters, etc.
6.2.4 FUNCTIONS OF SEBI
The SEBI performs functions to meet its objectives. To meet three
objectives SEB I has three important functions. These are:
1. Protective Functions:
These functions are performed by SEBI to protect the interest of the
investor and provide safety of the investment. As protective functions
SEBI performs the following functions:
a. It Checks P rice Rigging:
Price rigging refers to manipulating the prices of securities with the main
objective of inflating or depressing the market price of securities. SEBI
prohibits such practice because this can defraud and cheat the investors.
b. It Prohibits Insid er trading:
Insider is any person connected with the company such as directors,
promoters, etc. These insiders have sensitive information which affects the
prices of the securities. This information is not available to people at large
but the insiders get this privileged information by working inside the
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76 as insider trading, e.g., the directors of a company may know that
company will issue Bonus shares to its shareholders at the end of the year
and they purchase shares from market to make profit with bonus issue.
This is known as insider trading. SEBI keeps a strict check when insiders
are buying securities of the company and takes strict action on insider
trading.
c. It prohibits fraudu lent and Unfair Trade Practices:
SEBI does not allow the companies to make misleading statements that
are likely to induce the sale or purchase of securities by any other person.
SEBI undertakes steps to educate investors so that they can evaluate the
securities of various companies and select the most profitable securities.
d. SEBI promotes fair practices and code of conduct in the security
market by taking the following steps:
SEBI has issued guidelines to protect the interest of debenture -holders
wherein co mpanies cannot change terms in a midterm.
SEBI is empowered to investigate cases of insider trading and has
provisions for stiff fines and imprisonment.
SEBI has stopped the practice of making preferential allotment of shares
unrelated to market prices.
2. Developmental Functions :
These functions are performed by the SEBI to promote and develop
activities in the stock exchange and increase the business in the stock
exchange. Under developmental categories following functions are
performed by SEBI:
a. SEBI promote s the training of intermediaries of the securities market.
b. SEBI tries to promote activities of stock exchange by adopting a
flexible and adaptable approach in the following way:
c. SEBI has permitted internet trading through registered stock brokers.
d. SEBI has made underwriting optional to reduce the cost of the issue.
e. Even an initial public offer of the primary market is permitted through
the stock exchange.
3. Regulatory Functions:
These functions are performed by SEBI to regulate the business in the
stock excha nge. To regulate the activities of the stock exchange following
functions are performed:
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77 a. SEBI has framed rules and regulations and a code of conduct to
regulate the intermediaries such as merchant bankers, brokers,
underwriters, etc.
b. These intermediaries have been brought under the regulatory
purview and private placement has been made more restrictive.
c. SEBI registers and regulates the working of stockbrokers, sub -
brokers, share transfer agents, trustees, merchant bankers, and all
those who are associated with the stock exchange in any manner.
d. SEBI registers and regulates the working of mutual funds etc.
e. SEBI regulates the takeover of the companies.
f. SEBI conducts inquiries and audits of stock exchanges.
6.2.5 Investor’s protection measures of SEBI
SEBI has been established with the primary objective of protecting the
interests of investors in securities. An investor can invest his money safely
and profitably if:
1) He knows how to invest.
2) He has full knowledge of the market.
3) The market is safe and there are n o unfair practices.
4) There are arrangements for redressal in case of grievances.
Accordingly, SEBI’s investor protection measures have four elements.
1. SEBI educates and trains investors to make informed investment
decisions. It makes them aware of availabl e information required for
making the right investment decisions, to suit their specific investment
goals. SEBI has been organizing investor education and awareness
workshops. It has a special website for investors. It gives
precautionary messages through various media. It answers the queries
of investors through telephone, emails, and letters, and in -person for
those who visit the SEBI office.
2. It has prescribed rules and regulations to the companies and
intermediaries for disclosing relevant information t o the public to
helps them to make informed investment decisions.
3. It ensures that the market has systems and practices to make
transactions safe and secured. It has introduced various measures such
as a screen -based trading system, dematerialization of se curities, T + 2
rolling settlement to protect the interests of investors in securities.
4. It facilitates the redressal of investor grievances against intermediaries
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78 in stock exchanges and de positories for the settlement of disputes of
the investors.
6.3 STOCK EXCHANGE
Stock Exchange is also called Stock Market or Share Market. It is one
important constituent of the capital market. The stock exchange is an
organized market for buying and sell ing corporate and other securities. It
is a convenient place where trading in securities is conducted
systematically i.e. as per certain rules and regulations. The securities
include shares and debentures issued by public companies which are duly
listed at the stock exchange and bonds and debentures issued by the
government, public corporations, and municipal and port trust bodies.
London stock exchange (LSE) is the oldest stock exchange in the world.
Similar large Stock exchanges exist and operate in the m ajority of
countries of the world.
6.3.1 Definitions of Stock Exchange :
According to Husband and Dockerary , “Stock exchanges are privately
organized markets which are used to facilitate trading in securities.”
The Indian Securities Contracts (Regulation) Act of 1956 , defines
Stock Exchange as, “An association, organization or body of individuals,
whether incorporated or not, established to assist, regulate and controlling
business in buying, selling and dealing in securities.”
 Stock Exchange plays an impor tant role in the capital market.
Stock exchanges serve as:
1. Primary markets where corporations, governments, municipalities, and
other incorporated bodies can raise capital b y channeling savings of
the investors into p roductive ventures; and
2. Secondary markets where investors can sell their securities to other
investors for cash.
On modern exchange trades are conducted over the telephone or online.
Almost all exchanges are ‘auction exchanges’, where buyers enter
competitive bids and sellers enter competitive orders through a trading
day. Some European exchanges, however, use the 'periodic auction'
method in which round -robin calls are made once a trading day. The first
stock exchange was opened in Amsterdam in 1602. The three largest
exchanges in the world are (in descending order) New York Stock
Exchange (NYSE) , London Stock Exchange (LSE) , and the Tokyo Stock
Exchange (TSE) .
A stock exchange do es not own shares. Instead, it acts as a market where
stock buyers connect with stock sellers. Stocks can be traded on one or
more of several possible exchanges such as the Bombay Stock Exchange
(BSE). Although you will most likely trade stocks through a b roker, it is
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79 companies, and how the requirements of different exchanges protect
investors. To be traded, every stock must list on an exchange where buyers
and sellers meet. The two big U.S. exchanges are the BSE and NSE.
Companies listed on either of these exchanges must meet various
minimum requirements and baseline rules concerning the "independence"
of their boards. But t hese are by no means the only legitimate exchanges.
Electronic communication networks are relatively new, but they are sure
to grab a bigger slice of the transaction pie in the future. Finally, the OTC
market is a fine place for experienced investors with an itch to speculate
and the know -how to conduct a little extra due diligence.
The primary function of an exchange is to help provide liquidity; in other
words, to give sellers a place to "liquidate" their shareholdings.
Stocks first become available on an exchange after a company conducts
its initial public offering (IPO). In an IPO, a company sells shares to an
initial set of public shareholders (the primary market). After the IPO
"floats" shares i nto the hands of public shareholders, these shares can be
sold and purchased on an exchange (the secondary market ).
The exchange tracks the flow of orders for each stock, and this flow o f
supply and demand sets the stock price. Depending on the type of
brokerage account you have, you may be able to view this flow of price
action. For example, if you see that the "bid price" on a stock is Rs.200,
this means somebody is telling the exchange that he or she is willing to
buy the stock for Rs.200. At the same time, you might see that the "ask
price" is Rs.200, which means somebody else is willing to sell the stock
for Rs.210. The difference between the two is the bid-ask spread .

Company:
When a company requires capital to expand, it can either approach a
financial institution to borrow money or ask the general public to invest in
the company. In the case of the latter, the com pany has to approach an
investment bank, which will help it get listed on the stock exchange.
Shareholders, traders, and brokers can trade the company's stock once it is
listed on the stock exchange.
Stock exchange:
The stock exchange serves as a platform that helps companies raise capital
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80 trading handset the exchange even after the company is listed. The price of
the stock is determined by the demand, supply, and market demogra phics
at a particular time, and keeps changing by the minute.
Buyers/Sellers:
When a company is listed on the stock exchange, traders/investors buy and
sell stocks intending to make money through price fluctuations. These
traders/investors can be individua ls, corporate entities, governments, etc.
Brokers:
Brokers or brokering houses are middlemen between the buyers/sellers
and the stock exchange. They have the authority to carry out a transaction
on the behalf of the buyer or seller. The investor must manda torily have a
brooking account to trade/invest in stocks. Brokers charge an additional
fee for the service they provide, which is known as brokerage.
6.3.2 Importance Or Functions of Stock Exchange
We discuss major functions of stock exchange under these h eadings: -

1. Providing a ready market:
The Organization of Stock Exchange provides a ready market to
speculators and investors in industrial enterprises. It thus, enables the
public to buy and sell securities already in issue.
2. Providing a quoting marke t price:
It makes possible the determination of supply and demand on price. The
very sensitive pricing mechanism and the constant quoting of market price
allow the investors to always be aware of values. This enables the
production of various indexes which indicate trends etc.
3. Providing facilities for working:
It provides opportunities to Jobbers and other members to perform their
activities with all their resources in the stock exchange
4. Safeguarding activities for investors:
The Stock Exchange render s safeguarding activities for investors which
enable them to make a fair judgment of securities. Therefore directors
have to disclose all material facts to their respective shareholders. Thus
innocent investors may be safeguard from the clever brokers.
5. Operating a compensation fund:
It also operates a compensation fund which is always available to
investors suffering loss due to the speculating dealings in the stock
exchange.
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81 6. Creating the discipline:
The Members are controlled under a rigid set of ru les designed to protect
the general public and its members. Thus this tendency creates discipline
among its members in their social life also.
7. Checking functions:
New securities are checked before being approved and admitted to the
listing. Thus stock e xchange exercises rigid control over the activities of
its members.
8. Adjustment of equilibrium:
The investors in the stock exchange promote the adjustment of equilibrium
of demand and supply of a particular stock and thus prevent the tendency
of fluctuat ion in the prices of shares.
9. Maintenance of liquidity:
Banking and Insurance companies purchase a large number of securities
from the stock exchange. These securities are marketable and can be
turned into cash at any time. Therefore banks prefer to keep securities
instead of cash in their reserve. It facilitates the banking system to
maintain liquidity by procuring marketable securities .
10. Promotion of the habit of saving:
Stock exchange provides a pla ce for saving to the general public. Thus it
creates the habit of thrift and investment among the public. This habit
leads to an investment of funds incorporate or government securities. The
funds placed at the disposal of companies are used by them for pr oductive
purposes.
11. Refining and advancing the industry:
Stock exchange advances the trade, commerce, and industry in the
country. It provides an opportunity for capital to flow into the most
productive channels. Thus the flow of capital from the unprod uctive field
to the productive field helps to refine large -scale enterprises.
12. Promotion of capital formation:
The Stock Exchange plays an important part in capital formation in the
country. The publicity regarding various industrial securities makes ev en
disinterested people feel interested in investment.
13. Increasing Government Funds:
The Government can undertake projects of national importance and social
value by raising funds through the sale of its securities on a stock
exchange.
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82 6.3.3 Speculator s of Stock Exchange
 Meaning:
The speculators are traders of securities on stock exchanges. They are
engaged in buying and selling securities to earn profits. They are not
investors. They buy securities with the hope to sell them in the future at a
profit. They do not hold the securities for a longer period. They are more
concerned with price movements on stock exchanges.
In reality, there is no much difference between a speculator and an
investor. Each investor is to a certain extent - a speculator as he also buys
the securities with the hope of selling them at a higher price in the future.
Similarly, every speculator to a certain extent is an investor because he
may also hold the securities for some period with the hope of selling them
at a higher price. Thus, the difference between the two is a matter of
degree only.
 Types of Speculators
Four types of speculators trade on stock exchanges are as follows.
1. Bull:
A bull is an optimistic speculator. He expects a rise in the price of the
securities in which he deals. Therefore he buys the securities with the
hope of selling them in the future at a higher price and gain profits. If
it happens he can sell the securities. Thus he is not required to take
delivery of the securities.
2. Bear:
A bear is a pessimist ic speculator who expects a sharp fall in the prices
of certain securities. He, therefore, enters into selling contracts in
certain securities on a future date. If the price of the security falls as
per his expectations he will get the price difference.
3. Stag:
He is a cautious investor as compared to the bulls or bears. He only
applies for IPOs of the companies to sell them at a premium or profit
as soon as he gets the shares allotted.
4. Lame Duck:
When a bear cannot fulfill his commitment immediately, he is called a
lame duck.
6.4 BOMBAY STOCK EXCHANGE ( BSE )
Established in 1875, BSE Ltd. (formerly known as Bombay Stock
Exchange Ltd.), is Asia’s first Stock Exchange and one of India’s leading
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83 of the Indian corporate sector by providing it an efficient capital -raising
platform. Popularly known as BSE, the bourse was established as "The
Native Share & Stock Brokers' Association" in 1875. BSE is a
corporatized and demutualized entity, with a broad shareholder base that
includes two leading global exchanges, Deutsche Bourse and Singapore
Exchange as strategic partners.
BSE has won several awards and recognitions that acknowledge the work
done and progress made like The Golden Peacock Glo bal CSR Award for
its initiatives in Corporate Social Responsibility, NASSCOM - CNBC -
TV18’s IT User Awards, 2010 in Financial Services category, Skoch
Virtual Corporation 2010 Award in the BSE StAR MF category and
Responsibility Award (CSR) by the World Co uncil of Corporate
Governance. Its recent milestones include the launching of BRICSMART
indices derivatives, BSE -SME Exchange platform, S&P BSE GREENEX
to promote investments in Green India.
BSE forecast for 2014:
The BSE Sensex is forecast to scale new highs next year after elections,
attracting offshore funds despite an expected rough period for emerging
markets when the U.S. Federal Reserve shifts moneta ry policy, a Reuter’s
poll showed.
The poll predicts a better performance than this year's 9 percent increase
but far more modest than the 25 percent surge in 2012 when foreign
investors bought a massive $24.4 billion worth of Indian stocks.
Uncertainty ab out the outcome of the elections, due by May, has prompted
many investors and businesses to delay decisions as there are no clear
favorites among leading parties to win a majority when India goes to
elections.
Starmine data shows seven of the 30 companies that make up the index
will likely see earnings drop next fiscal year. Six of those are companies in
the heavy machinery and power sectors that have traditionally been reliant
on government policies, subsidies, and tax exemptions.
6.5 DEMATERIALISATION
During the late eighties, the common man used to stay away from the
stock market because of the sheer complexity of the paperwork involved
in trading at the market. This resulted in a very low mobilization of funds
in the market. Besides this, the paper -based system also gave rise to
several problems duplication of shares, fake shares, fake signatures,
signature mismatches, and transfer problems. Stock certificates became
the major reason for rising arbitration cases and investor disputes. This
fact created a need for a more technologically advanced system to
maintain records of all the transactions. The government of India decided
to bring a fully automated system for book -keeping, to eliminate all the
risks that came along with the paper -based certificates. The depository
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84 eliminating the paper -based system and made way for the safer electronic
system in which every investor made transactions using a DEMAT
Account.
A concept of reducing the numb er of materials required to serve economic
functions. Signifies conversion of a share certificate from its present
physical form to electronic form for the same number of holding. It
attempts to avoid the time -consuming and complex process of getting
share s transferred in the name of the buyers.
Dematerialization of shares is optional and an investor can still hold shares
in physical form. However , he/she has to DEMAT the shares if he/she
wishes to sell the same through the Stock Exchanges. Similarly, if an
investor purchases shares, he/she will get delivery of the shares in
DEMAT form only.
It offers scope for paperless trading through state -of-the-art technology,
whereby share transactions and transfers are processed electronically
without involving any share certificate or transfer deed after the share
certificates have been converted from physical form to electronic form.
6.5.1 Process of Dematerialisation :
Any person should open a DEMAT account with any Depository
Participant (DP). The DP acts like an agent between the investor and
depository. The process is as follow:
1. He/she has to fill up an online DEMAT account opening form and
needs to surrender the certificate(s) to the DP. The DP then sends the
form and the original share certificates and the documents for proof of
his identity and address and self -attested passport size photograph to
the concerned Registrar & Transfer (R&T) agent. To avoid any misuse
of the share certificates, the investor must ensure that they are defaced
by marking “Sur rendered for Dematerialization” on the face of the
certificates.
2. The person will have to sign a pact with his DP in which all the rules
and regulations will be written to be followed by the investor and DP
both. The DP gives a copy of the agreement to the investor.
3. After signing the agreement and the verification of the documents, in
about 15 days the person will get his online account number. It is also
known as BO ID that is Beneficiary Owner’s Identification Number.
All your future transactions will be d one with this ID.
4. The R&T agent holds the details about the shares. He checks with
the signature of the applicant and processes it and intimate about this
to the company & NSDL.
5. On receiving intimation from the R&T agent, NSDL or CDSL credit
the secur ities in the depository account of the client with the DP and
inform the client accordingly. It should not take more than 30 days
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85 dematerialized. Finally, the investor gets the DEMAT shares through
his/her DP.
A person having a DEMAT account, can step into the world of the stock
exchange and start investing the money in mutual funds , shares,
debentures , insurance , retirement funds , etc. Unlike the bank account, the
person has not kept a minimum balance, the DEMAT account does not
require the minimum number of securities.
6.5.2 Key Concepts involved in the process of Dematerialisation :
1. Depository:
Regulates and co ntrols the various activities of the Depository
Participants. There are two depositories in India :
 NSDL – National Securities and Depositories limited
 CDSL – Central Depositories Securities limited
2. Depositary Participant:
This is a rep resentative for the depository and it acts as an interface
between the clients and the depository.
 Functions of DP:
a. DEMAT Account opening
b. Dematerialization of securities
c. Account statement
d. Pledging
e. Process delivery Instruction slip
3. Registrar :
He ke eps a record of applications and money received from investors.
Assisting issuing companies in determining the basis of allotment of
securities, dispatching allotment letters, dispatching of refund orders,
shares, etc.
4. Transfer agents:
He keeps a Record of holders of securities on behalf of the company,
handling all matters related to the transfer and redemption of securities of
the company.
5. Beneficiary account:
A beneficiary account is an account opened by the investor with the DP.
Every beneficiary acc ount will be given a unique ID. In NSDL, the BO ID
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86 6. DEMAT account:
This account is like a bank account and it shows the shares we have. Like
cheque leaf in the b ank, here we have Delivery Instruction Slip to transfer
our shares to some other persons.
6.5.3 Advantages of Dematerialisation:
 Reduces brokerage charges.
 Eliminates the risks involved with physical certificates like forgery,
loss, theft, damage of certificates, etc.
 There is no paperwork inv olved which has greatly reduced the time
required.
 Traders don’t need to visit the stock market again and again as they
can operate it from anywhere as the system is electronic.
 The system reduces the cost incurred by the company in issuing and
distributin g shares.
6.5.4 Disadvantages of Dematerialisation:
 Trading in securities may become uncontrolled.
 The biggest limitation is that to have a DEMAT account one needs
to be internet savvy and therefore people who are not that literate
with the internet w ill find it hard to operate their DEMAT
account and therefore they tell their brokers or sub -brokers to
transact on behalf of them which sometimes lead to fraud and
mismanagement of funds by the sub -brokers.
 Another limitation is that since stocks are d ematerialized individuals
tend to keep looking at the stock price more often than they would
have if stocks were in paper form and therefore they end up doing
trading instead of investment.
 Multiple regulatory frameworks have to be confirmed.
 Agreements ar e entered at various levels in the process of
dematerialization. These may cause worries to the investor
desirous of simplicity.
 There is no provision to close a Demat account, which is having
illiquid shares.
Check Your Progress
1. Define the following terms ;
a. SEBI
b. Stock exchange
c. DEMAT account munotes.in

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87 d. Depository
e. Beneficiary account
f. Dematerialization
2. Enlist the functions of the stock exchange.
3. Explain the management structure of SEBI.
6.6 CREDIT RATING AGENCIES (CRA)
Credit rating is an analysis of the credit risks associated with a financial
instrument or a financial entity. It is a rating given to a particular entity
based on the credentials and the extent to which the financial statements of
the entity are sound, in terms of borrowing and lending that has been don e
in the past. Usually, is in the form of a detailed report based on the
financial history of borrowing or lending and creditworthiness of the entity
or the person obtained from the statements of its assets and liabilities to
determine their ability to mee t the debt obligations. It helps in the
assessment of the solvency of the particular entity.
Definition:
“Credit Rating is an opinion expressed by an independent rating agency
about the credit quality of the issuer of a debt instrument”.
The credit rati ng of debt security essentially reflects the probability
payment of interest and repayment of principal amount by a borrower.
“A credit rating agency is a company that assigns credit ratings to
institutions that issue debt obligations”.
Credit rating mea sures creditworthiness, or the ability to pay back a loan.
Credit rating is done for debt instruments such as debentures, fixed
deposits, commercial papers, bonds, etc. The company which issues debt
instruments is called an issuer or issuing company. An in vestor looks at
the credit rating of the instrument and issuer before investing. If the credit
rating is high, the investor will invest in the company. That is, he will
purchase the debentures, bonds, etc. issued by that company. If the credit
rating is low, the investor will not purchase the debentures, bonds, etc. of
that company. So credit rating guides the investor while investing. Credit
rating is an opinion about a debt instrument and its issuer. It tells an
investor, whether the debt instrument is safe or risky. It tells whether the
issuer will be able to pay the interest and repay the principal amount in
time. Credit rating is only an opinion. It is not a recommendation. It does
not ask an investor to buy, hold or sell an instrument.
6.6.1 ROLE / ADVANTAGES OF CREDIT RATING AGENCIES:
1) Collection of financial information:
Credit rating agencies collect valuable information relating to the credit
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88 and summarized in a sim ple and readily understood manner. The rating
agency is likely to provide unbiased information.
2) Supply of information:
The information about the credit quality of an issuer is provided to the
public. This helps them in making an investment decision. Th e
information is also supplied to others like SEBI, bankers government, etc.
3) Provides the basis for assessing risk and return:
The ratings are evaluated and revised from time to time, and as such it
helps the existing investors to decide whether or not to hold on to the
security or to dispose of it off. The information provided to the potential
investors enables them to decide whether or not to invest in debt
securities.
4) Corporate Discipline:
Credit rating imposes healthy discipline on corporate bo rrowers. Firms
would naturally prefer a better credit rating as a higher credit rating tends
to enhance the corporate image and visibility of the firms. Therefore, they
maintain financial discipline i.e. regular payment of interest and
repayment of debt on time.
5) Guidance to institutional investors:
Credit rating agencies facilitate the formulation of public policy guidelines
on institutional investment. This helps them to plan their investment
portfolios easily and earn better returns.
6) Provide Greate r Credence:
Credit rating agencies provide greater credence to financial and other
representations. When a credit rating agency rates particular security, its
credibility is at stake, and as such, it would make all possible efforts to
collect proper finan cial information about the credit quality of the issuer
and that of the debt instrument.
At times, it has been observed that the companies that provide debt
products and services are rating the debt instruments by them.
The providers of securities like th e companies, the governmental
organizations at the state and central level, and special purpose entities are
the major clients of the credit rating agencies. The non -profit -seeking
organizations and the national governments also avail the services of the
credit rating agencies.
6.6.2 BENEFITS OF CREDIT R ATING COMPANY:
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89 3. A wider audience of borrowings
4. Good for nonpopular companies
5. Act as a marketing tool
6. Helps for growth and expansion
6.6.3 Credit Rating an d Information Services of India Ltd.
(CRISIL):
CRISIL is India's global analytical company providing ratings, research,
and risk and policy advisory services. CRISIL’s businesses can be divided
into three broad categories - Ratings, Research and Advisory. CRISIL
Ratings has assessed over 61,000 entities in India. Its rating capabilities
span the entire range of debt instruments and it has worked across the
corporate strata, from large corporations in the country to SMEs.
CRISIL was established in 1987. The world’s largest rating agency
Standard & Poor's now holds a majority stake in CRISIL. It has been
promoted by Industrial Credit and Investment Corporation of India Ltd.
(ICICI) and Unit Trust of India Ltd. (UTI) as a public limited company
with its headqu arters in Mumbai.
Under Research, CRISIL Global Research and Analytics serves global
investment banks and financial institutions with high -end research, risk,
analytics, and equity and credit research services. Its credit research
supports 80 percent of th e global structured finance market and over 60
percent of the global credit markets. The company's equity research covers
over 90 percent of the global trading volumes and 88 percent of the global
market capitalization. In India, CRISIL Research is an inde pendent and
integrated research house. It provides the following information:
6.6.4 Functions of CRISIL
1. It provides growth forecasts, profitability analysis, emerging trends,
expected investments, industry structure, and regulatory frameworks.
CRISIL's ra ting experience covers more than 24654 entities, including
14,500 small and medium enterprises.
2. CRISIL offers domestic and international customers with independent
information, opinions, and solutions related to credit ratings and risk
assessment; energy i nfrastructure and corporate advisory; research on
India's economy, industries, and companies; global equity research;
fund services; and risk management.
3. CRISIL Infrastructure Advisory is a division of CRISIL Risk and
Infrastructure Solutions (CRIS) Limit ed, a wholly -owned subsidiary of
CRISIL Limited. It helps shape policy and establish viable frameworks
to improve the risk profile of infrastructure projects. It works with
government agencies in enhancing their capacity, capabilities, and
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4. CRISIL Risk Solutions (CRS), the other division of CRIS, provides a
range of risk management tools, analytics, and solutions to financial
institutions, banks, and cor porate, in India, and across the world.
The rating is an opinion on the future ability and legal obligation of the
issuer of securities to make timely payments of principal and interest on
specific fixed income security such as debentures.
6.6.5 CRISIL R ole:
The role of CRISIL can be divided into two groups:
 Specific Roles
 General Roles
1. Specific Roles :
CRISIL’s businesses can be divided into four broad categories:
 Ratings
 Research
 Advisory
 Risks Management
2. General Roles :
The general roles of CRISIL are as follows:
a) It supplies credit rating information to the public.
b) It provides the basis for assessing risk and return for an investment.
c) It imposes good discipline on corporate borrowers.
d) It facilitates the formulation of public policy.
e) It protects inv estor interests.
Thus, CRISIL was the first credit rating agency in India, which was set up
in 1987. There are also other credit rating agencies such as CARE and
ICRA. Investors rely on credit ratings and invest in good performing firms
or firms with good potential. Therefore, firms are in a position to raise
medium -term to long -term funds from the capital markets. This gives a big
boost to capital markets in India.
6.6.6 Credit Analysis and Research Ltd. (CARE)
Credit Analysis & Research Ltd (CARE) commenc ed its operations in the
year 1993 has established itself as the leading credit rating agency of
India. The company provides various credit ratings that help corporates to
raise capital for their various requirements and assist the investors to form
inform ed investments decision based on the credit risk and their own risk -
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91 full service rating company that offers a wide range of rating and grading
services across sectors. The company is r ecognized by Securities and
Exchange Board of India (Sebi) Government of India (GoI) and Reserve
Bank of India (RBI) etc.
The company was promoted by major Banks/ FIs (financial institutions) in
India. The company carries out rating of the debt instrument s namely
structured obligations Commercial paper Debentures Fixed deposits and
Bonds covering the full spectrum of Universe comprising Industrial
Companies Service companies Infrastructure companies Banks Financial
Institutions (FIs) Non -Bank Finance compa nies (NBFCs) Public Sector
Undertakings (PSUs) State Government Undertakings Municipal
Corporations Structured Finance Transactions Securitization Transactions
SMEs SSI and Micro Finance Institutions.
In addition to debt ratings the company has experience in providing
specialized grading/rating services such as Corporate Governance ratings
IPO grading Mutual Fund Credit quality Ratings Insurance Claims Paying
Ability Ratings Issuer Ratings Grading of Construction entities Grading of
Maritime training insti tutes and LPG/ SKO Ratings.
6.6.7 ICRA Limited Formerly Known as - Information and Credit
Rating Agency of India Ltd. (ICRA)
ICRA Limited (formerly Investment Information and Credit Rating
Agency of India Limited) was set up in 1991 by leading
financial/in vestment institutions, commercial banks and financial services
companies as an independent and professional investment Information and
Credit Rating Agency.
Today, ICRA and its subsidiaries together form the ICRA Group of
Companies (Group ICRA). ICRA is a Public Limited Company, with its
shares listed on the Bombay Stock Exchange and the National Stock
Exchange.
Alliance with Moody’s Investors Service
The ultimate parent company of international Credit Rating Agency
Moody’s Investors Service is the indirect largest shareholder of ICRA.
The participation of Moody’s is supported by a Technical Services
Agreement, which entails Moody’s providing certain technical services to
ICRA. Specifically, the agreement is aimed at benefiting ICRA’s in -house
research capab ilities by providing ICRA with access to Moody’s global
research base. Under the agreement Moody’s provides enrichment
programs to ICRA employees, including access to the financial markets
and related courses that are offered as part of the eLearning softw are
licensed by Moody’s from Intuition, and provision of financial writing
training seminars to designated ICRA employees.

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92 Services of ICRA
 Provide information and guidance to institutional and individual
investors/creditors;
 Enhance the ability of borro wers/issuers to access the money market
and the capital market for tapping a larger volume of resources from a
wider range of the investing public;
 Assist the regulators in promoting transparency in the financial
markets;
 Provide intermediaries with a tool to improve efficiency in the funds
raising process.
6.7 SUMMARY
The Securities and Exchange Board of India describes the basic Functions
as, "...to protect the interests of investors in securities and to promote the
development of the securities market, a nd to regulate the securities market
and for matters connected therewith or incidental thereto".
Stock Exchange is an association of people organized to provide an
auction market among themselves for the purchase and sale of securities.
It is one importan t constituent of the capital market. Stock Exchange is an
organized market for the purchase and sale of industrial and financial
security.
CRAs play a key role in financial markets by helping to reduce the
informative asymmetry between lenders and investor s, on one side, and
issuers on the other side, about the creditworthiness of companies. CRISIL
is the largest credit rating agency in India
6.8 EXERCISE
Multiple Choice Questions
1. ____________ was set up with the main purpose of keeping a check on
malpr actices and protect the interest of investors
a) SEBI b) RBI c) CBI d) SBI
2. SEBI has been established with the primary objective of
_____________
a) protect the interest of investors b) defraud the investors c) Ignore
the Investors d) None of the abo ve
3. Stock Exchange is also called _____________
a) Share Market b) Debenture Market c) Deposits Market d)
Financial Market
4. In ___________ market New and Fresh shares are traded
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93 5. In ___________ market exi sting shares are traded
a) Primary b ) Secondary c) Money d) Private
6. ___________ market deals with short term securities
a) Primary b ) Secondary c ) Money d) Private
7. A ___________is an optimistic speculator
a) Bear b) Stag c) Bull d) Lame Duc k
8. ___________ expects a rise in the price of the securities in which he
deals
a) Bear b) Stag c) Bull d) Lame Duck
9. A ___________is an pessimistic speculator
a) Bear b) Stag c) Bull d) Lame Duck
10. ______________ expects a sharp fall in t he prices of certain securities
a) Bear b) Stag c) Bull d) Lame Duck
11. _______________ only applies for IPOs of the companies to sell them
at a premium or profit as soon as he gets the shares allotted
a) Bear b) Stag c) Bull d) Lame Duck
12. __________ holds the securities of investors and provides services to
them
a) Depositary b) SEBI c) RBI d) Companies
13. The electronic mode of holding and transferring shares is called the
_____________ of securities.
a) Dematerialization b) Remateri alization c) Physical form d) E
holding
Theory Questions
1. 'In today's commercial world, SEBI performs many vital functions
which leads the investors towards a positive environment.' Explain
how by giving any reasons.
2. Define stock exchange. Describe the ro le of the stock exchange in an
economy.
3. Briefly explain dematerialization and its benefits.
4. Discuss the role and functions of the Securities and Exchange Board
of India.
5. “SEBI is set up to protect the interest of investors”. Discuss.
6. What is a credit ratin g? Explain the functions of credit rating.
7. Write a detailed note on Credit Rating Agencies in India.


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94 8. Write Short notes:
a. Credit Rating Agencies
b. CRISIL
c. SEBI
d. Bombay Stock Exchange.
f. Role of Depositories
g. SEBI’s investor protection measures
9. Explain the terms
a. IPO
b. Depository
c. Speculators
d. Bull
e. Bear



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95 7
CONTEMPORARY PRACTICES IN
FINANCIAL MARKETS
Unit Structure
7.0 Objectives
7.1 Mutual Fund
7.2 Derivatives Market
7.3 Start -Up Ventures
7.4 Micro -Finance
7.5 Self Help Groups
7.6 Summary
7.7 Exercise
7.0 OBJECTIVES
After studying the unit the student s will be able to:
 Understand the concept of Mutual Fund.
 Discuss the factors responsible for the growth of
 Mutual Fund and its types.
 Define Derivative Market.
 Explain the types of Derivative Market and the participants in the
Derivative Market
 Define Venture Capital and microfinance.
 Discuss the features of Venture Capital.
 Elaborate on the role of Micro Finance.
7.1 MUTUAL FUND
A mutual fund is a mechanism for pooling the resources by issuing units
to the investors and investing funds in securities in accordance with
objectives as disclosed in the offer document.
Investments in securities are spread across a wide cross -section of
industries and sectors and thus the risk is reduced. Diversification reduces
the risk because all stocks may not move in the same direction in the same
proportion at the same time. Mutual fund issues units to the investors in
accordance with the quantum of money invested by them. Investors of
mutual funds are known as unitholders .
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96 The profits or losses are shared by the invest ors in proportion to their
investments. The mutual funds normally come out with several schemes
with different investment objectives which are launched from time to time.
A mutual fund is required to be registered with the Securities and
Exchange Board of India (SEBI) which regulates securities markets before
it can collect funds from the public.
Mutual funds represent one of the organizational forms of the delegated
portfolio management, in which fund shareholders delegate the task of
allocating their mone y to the fund manager. Since the manager’s objective
are not necessarily identical to those of the fund’s shareholders, a potential
agency problem arises: the agent may not pursue investment policies
optimal for the principals (fund shareholders)
Mutual fu nds are typically organized as corporations and have a board of
directors or trustees, which is elected by the shareholders.
In contrast to most business corporations, mutual funds are very limited
internal resources and rely on the provision of specific services by
affiliated organizations and independent contractors. In particular, the
board of directors hires a separate entity - the investment advisor/
management company - to provide all management and advisory services
to a fund for a fee, which is usual ly based on a percentage of the fund’s
average net assets.
In practice, however, the usual procedure is for the management
organization to create mutual funds. To mitigate a potential conflict of
interest, the ICA requires that an investment advisor must s erve under a
written contract approved initially by a vote of the shareholders and
thereafter approved annually by the board of directors.
7.1.1 History of Mutual Funds:
Unit Trust of India was the first mutual fund set up in India in the year
1963. In th e early 1990s, the Government allowed public sector banks and
institutions to set up mutual funds.
As far as mutual funds are concerned, SEBI formulates policies and
regulates the mutual funds to protect the interest of the investors. SEBI
notified regulat ions for mutual funds in 1993. Thereafter, mutual funds
sponsored by private sector entities were allowed to enter the capital
market. The regulations were fully revised in 1996 and have been
amended thereafter from time to time. SEBI has also issued guide lines to
the mutual funds from time to time to protect the interests of investors.
All mutual funds whether promoted by the public sector or private sector
entities including those promoted by foreign entities are governed by the
same set of Regulations. T here is no distinction in regulatory requirements
for these mutual funds and all are subject to monitoring and inspections by
SEBI. The risks associated with the schemes launched by the mutual funds
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97 7.1.2 Types of Mutual Funds:
There are 3 principal types of mutual funds are:
Open -end funds, unit investment trusts (UITs), and closed -end
funds . Exchange -traded funds (ETFs) are open -end funds or unit
investment trusts that trade on an exchange; they ha ve gained popularity
recently. While the term "mutual fund" may refer to all three types of
registered investment companies, it is more commonly used to refer
exclusively to the open -end type.
1. Open -end fund:
Open -end mutual funds must be willing to buy back their shares from their
investors at the end of every business day at the net asset value computed
that day. Most open -end funds also sell shares to the public every business
day; these shares are also priced at net asset value. A professional
investm ent manager oversees the portfolio, buying and selling securities as
appropriate. The total investment in the fund will vary based on share
purchases, share redemptions, and fluctuation in market valuation. There
is no legal limit on the number of shares t hat can be issued.
2. Closed -end funds:
Closed -end funds generally issue shares to the public only once, when
they are created through an initial public offering . Their shares are then
listed for trading on a stock exchange . Investors who no longer wish to
invest in the fund cannot sell their shares back to the fund (as they can
with an open -end fund). Instead, they must sell their shares to another
investor in the market; the price they receive may be significantly different
from net asset value. It may be at a "premium" to net asset value (meaning
that it is higher than net asset value ) or, more commonly, at a "discount" to
net asset value (meaning that it is lower than net asset value). A
professional investment manager oversees the portfolio, buying and
selling securities as appropriate.
3. Unit investment trusts:
Unit investment trus ts or UITs issue shares to the public only once, when
they are created. UITs generally have a limited life span, established at
creation. Investors can redeem shares directly with the fund at any time (as
with an open -end fund) or wait to redeem upon the t ermination of the
trust. Less commonly, they can sell their shares in the open market. Unit
investment trusts do not have a professional investment manager. Their
portfolio of securities is established at the creation of the UIT and does not
change.
4. Sch emes according to the investment objective
Besides these, there are other types of mutual funds also to meet the
investment needs of several groups of investors. Some of them include the
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98 a) Income oriented schemes:
The fund primarily offers fix ed income to investors. Naturally enough, the
main securities in which investments are made by such funds are the fixed
income yielding ones like bonds.
b) Growth -oriented schemes:
These funds offer growth potentialities associated with an investment in
the capital market namely: 1) high source of income by way of dividend
and 2) rapid capital appreciation, both from holding good Quality scrips.
These funds, to satisfy the growth needs of investors, primarily
concentrate on the low risk and high yielding s pectrum of equity scrips of
the corporate sector.
c) Hybrid schemes:
These funds cater to both the investment needs of the prospective
investors - namely fixed income as well as growth orientation. Therefore,
investment targets of these mutual funds are a judicious mix of both the
fixed income securities like bond and debentures and also sound equity
scrip’s. These funds utilize the concept of balanced investment
management. These funds are thus, also known as “balanced funds”.
d) High Growth Schemes:
As the nomenclature depicts, these funds primarily invest in high risk and
high return violate securities in the market and induce the investors with a
high degree of capital appreciation. Aggressive investors willing to take
excessive risks are the normal ta rget group of such funds.
e) Capital Protection Orientated Scheme:
It is a scheme that protects the capital invested in the mutual fund through
a suitable orientation of its portfolio structure.
f) Tax Saving Schemes:
These schemes offer tax rebates to t he investors under tax laws as
prescribed from time to time. This is made possible because the
government offers a tax incentive for investment in specified avenues. For
example, Equity Linked Saving Schemes (ELSS) and pension scheme.
g) Special Schemes:
This category includes index schemes that attempt to replicate the
performance of a particular index such as BSE, Sensex, or the NSE -50 or
industry -specific scheme (which invest in specific industries) or sectoral
schemes (which exclusively in the segment such as ‘A’ group or initial
public offering). Index und schemes are ideal for investors who are
satisfied with a return approximately equal to that of an index. Sectoral
fund schemes are ideal for investors who have already decided to invest in
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99 h) Real Estate Funds:
These are close -ended mutual funds that invest predominantly in real
estate and properties.
i) Off -shore Funds:
Such funds invest in securities of foreign companies with RBI permission.
j) Leverage Funds:
Such funds, also known as borrowed funds, increase the size and value of
the portfolio and offer benefits to members from out of the excess of gains
over the cost of borrowed funds. They tend to indulge in speculative
trading and risky investment.
k) Hedge Fun ds:
They employ only their funds for speculative trading i.e., for buying
shares whose prices are likely to rise and for selling shares whose prices
are likely to dip.
l) Fund of Funds:
They invest only in units of other mutual funds. Such funds do not o perate
at present in India.
m) New Direction Funds:
They invest in companies engaged in scientific and technological research
such as birth control, anti -population, oceanography, etc.
n) Exchange Traded Funds:
A relatively recent innovation, the exchang e-traded fund or ETF is often
structured as an open -end investment company, though ETFs may also be
structured as unit investment trusts, partnerships, investments trust,
grantor trusts, or bonds (as an exchange -traded note ). ETFs, combine
characteristics of both closed -end funds and open -end funds. Like closed -
end funds, ETFs are traded throughout the day on a stock exchange at a
price determined by the market. Howeve r, as with open -end funds,
investors normally receive a price that is close to the net asset value. To
keep the market price close to net asset value, ETFs issue and redeem
large blocks of their shares with institutional investors.
o) Money Market Funds:
These funds invest in short -term debt securities in the money market like a
certificate of deposit, commercial papers, government treasury bills, etc.
Owing to their large size, the funds normally get a higher yield on such
short -term investments than on a n individual investor.

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100 p) Infrastructure Debt Fund:
They invest primarily in the debt securities or securitized debt investment
of infrastructure companies.
7.1.3 Advantages of Mutual Funds
An investor must be aware of the advantages and limitations of mutual
funds to choose the best fund for investment. The advantages of Mutual
Funds are as follows:
1. Diversification of risks:
Mutual fund managers invest the funds in different sectors and thus the
risks of investing in securities get reduced or diversifi ed.
2. Professional Management:
Investing in securities is not an easy task many factors are required to
be studied and analyzed before making an investment decision. The
advantage of mutual funds is that they are managed by professional
experts who can mak e the right investment decisions.
3. Simplicity:
Mutual fund dealers make available the required information about the
funds easily such as level of risk, return on investment, and the price
so the investor can choose the right type of mutual fund very easi ly.
4. Liquidity:
Liquidity refers to the ability to convert your assets to cash with
relative ease. An investor can get money by exiting the mutual fund
very easily and quickly.
5. Cost:
Mutual funds are one of the best investment options considering the
costs involved. A Portfolio Management Service may charge 2% to
3% of the total investment per year as its management fees. They may
deduct a share from your profit. Mutual funds are relatively cheaper
and deduct only 1% to 2% of the expense ratio. Debt mutu al funds
usually deduct even lesser.
6. Tax efficiency:
Mutual funds are relatively more tax -efficient than other types of
investment. Long -term capital gain tax on equity mutual funds is zero.
For debt funds, long -term capital gains apply when you hold the m for
3 years.

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101 7. Availability of more options:
Mutual funds are of different types based on the period of investment
and also sector -wise. This allows investors to invest in particular types
of funds, depending on their goals.
8. Requirement of a small amo unt:
Mutual Funds allow you to begin with as small as Rs. 500 or Rs.
1000/ - so a common man can also invest in mutual funds.
9. Automated Investment:
In a Systematic Investment Plan or SIP, the money gets automatically
debited from the investor’s account. So it is a very convenient way of
investing in mutual funds.
10. Safe and Transparent:
Investments in mutual funds are very transparent. All mutual funds are
regulated by SEBI and they need to make necessary disclosures.
11. Option to choose SIP or Lumpsum mutu al funds also give you the
flexibility to invest through SIP or lump sum.
7.1.4 Disadvantages of mutual funds
The disadvantages of mutual funds are as follows :
1. Costs:
Some mutual funds have a high cost associated with them. Mutual
funds charge for manag ing the funds. Even when an investor exits
from the mutual fund within a specified duration, there may be an
extra cost as exit load. Thus investors should be aware that different
funds have different expense ratios.
2. Dilution:
Diversification has an aver aging effect on your investments while
diversification protects the investor from suffering any major losses, it
also prevents from making any major gains. Thus, major gains get
diluted.
3. Costs to Manage Mutual Funds:
The salary of the market analysts a nd fund managers comes from the
investors. Total fund management charge is one of the first parameters to
consider when choosing a mutual fund. Higher management fees do not
guarantee better fund performance.
4. Fluctuating returns
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102 of your mutual fund. In other words, mutual funds entail a wide range of
price fluctuations. Professional management of a fund by a tea m of experts
does not insulate you from the bad performance of your fund.
5. No Control
All types of mutual funds are managed by fund managers. In many cases,
the fund manager may be supported by a team of analysts. Consequently,
as an investor, you do no t have any control over your investment. All
major decisions concerning your fund are taken by your fund manager.
However, you can examine some important parameters such as disclosure
norms, corpus, and overall investment strategy followed by an Asset
Mana gement Company (AMC).
6. Diversification
Diversification is often cited as one of the main advantages of a mutual
fund. However, there is always the risk of over -diversification, which may
increase the operating cost of a fund, demands greater due diligenc e, and
dilutes the relative advantages of diversification.
7. Fund Evaluation
Many investors may find it difficult to extensively research and evaluate
the value of different funds. A mutual fund's net asset value (NAV)
provides investors the value of a f und's portfolio. However, investors have
to study various parameters such as Sharpe ratio and standard deviation
among others to ascertain how one fund has fared compared to another
which can be complicated to some extent.
8. Past performance
Ratings and a dvertisements issued by companies are only an indicator of
the past performance of a fund. It is important to note that the robust past
performance of a fund is not a guarantee of a similar performance in the
future. As an investor, you should analyze the investment philosophy,
transparency, ethics, compliance, and overall performance of a fund house
across different phases in the market over a period of time. Ratings can be
taken as a reference point.
7.1.5 Factors responsible for the growth of mutual fund s
The various factors responsible for the growth mutual fund industry in
India can be given as follows:
1. Population:
In India, the percentage of the young and working population is
increasing at a higher rate. It results in higher per capita income,
highe r savings, and investments in equity markets. Also, there is
growing awareness of the benefits of investments in mutual funds,
both in urban and rural areas.
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103 2. Movement in Global Markets:
In India, the performance of equity markets is far better than in o ther
countries of the world. This has resulted in higher investments in
mutual funds.
3. The growing significance of the service industry:
The service sector is growing faster than the manufacturing sector. As
a result, professional services are available a t reasonable costs in India.
4. Inflation affects the Returns:
Inflation represents the general price level of the country and it is
increasing over a period of time. It affects the returns on fixed income
options such as bank deposits, PPF, National Servic e Certificates, and
so on. As a result, such traditional options of investing money are
becoming unpopular.
5. Other factors:
The other factors contributing to the growth of mutual funds in India
are - change in the attitudes of people, availability of seve ral mutual
funds even operated by public financial institutions, the impact of
globalization, and so on.
7.1.6 Systematic Investment Plan (SIP):
The terms SIP and mutual fund schemes are not synonymous. A SIP is
only a scheme that helps the investor to in vest regularly in mutual fund
schemes. Thus, SIP or systematic Investment Plan is a scheme in which an
investor invests a fixed amount of money regularly in a mutual fund,
generally an equity mutual fund scheme. An investor can start investing in
a mutual fund scheme with a minimum of Rs. 500. He can invest a fixed
amount of money monthly, bi -monthly, or forthrightly, according to his
convenience. In a step -up SIP scheme, an investor can increase the SIP
amount periodically. In Alert SIP, the mutual fund ma nagement sends an
alert to the investor to increase his investment when the markets are down.
In perpetual SIP; the investor can continue to invest periodically, without
any end date. He can exit the scheme as his requirements.
The following are the benef its of investing in mutual funds by using a SIP
scheme.
1. It is very convenient and time -saving as money gets automatically
debited from an investor’s account.
2. It helps to average purchase cost and maximize returns when an
investor invests regularly over a period of time irrespective of the
market conditions, he gets more units when the market is down and
fewer units when the market is up. This averages out the purchase cost
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104 3. It helps to build the habit of saving and invest regularly a mong the
people.
4. When an investor continues to invest over a long period, his returns
get compounded. After the expiry of a long period, he can accumulate
a large sum of money which ultimately helps him to achieve his long -
term financial goal.
Check Your Progress
1. Define the following terms:
a. Operating Leasing
b. Financial Leasing
c. Sale of Leaseback
d. Leverage lease
e. Mutual Fund
f. ETF
g. Open -end fund
h. Closed -end fund
2. Enlist the types of mutual funds which meet the investment needs of
several groups of investors.
3. Write the points of advantages of lease financing.
7.2 DERIVATIVES MARKET
The Derivatives Market is meant as the market where the exchange of
derivatives takes place. Derivatives markets are markets that are based
upon another market, which is known as the under lying market.
Derivatives markets can be based upon almost any underlying market,
including individual stock markets (e.g. the stock of company XYZ), stock
indices (e.g. the Nasdaq 100 stock index), and currency markets (i.e. the
forex markets). Derivative s markets take many different forms, some of
which are traded in the usual manner (i.e. the same as their underlying
market), but some of which are traded quite differently (i.e. not the same
as their underlying market).
7.2.1 Meaning Of Derivative :
Deriva tives are one type of securities whose price is derived from the
underlying assets or derivatives are products whose value is derived from
one or more basic variables called underlying assets or base.
In simpler form, derivatives are financial security su ch as an option or
future whose value is derived in part from the value and characteristics of
another underlying asset.
Derivative contracts can be standardized and traded on the stock
exchange. Such derivatives are called exchange -traded derivatives. Or
they can be customized as per the Over -the-counter (OTC) derivatives.
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105 A Derivative includes:
(a) A security derived from a debt instrument, share, loan, whether secured
or unsecured, risk instrument or contract for differences or any other
form of secu rity;
(b) A contract that derives its value from the prices, or index of prices, of
underlying securities.
The primary objectives of any investor are to bring an element of certainty
to returns and minimize risks. Derivatives are contracts that originated
from the need to limit risk. The value of these derivatives is determined by
the fluctuations in the underlying assets. These underlying assets are most
commonly stocks, bonds, currencies, interest rates, commodities, and
market indices.
As Derivatives are merely contracts between two or more parties, anything
like weather data or amount of rain can be used as underlying assets. The
Derivatives can be classified as Future Contracts, Forward Contracts,
Options, Swaps, and Credit Derivatives. Futures, options , and swaps are
complicated instruments. However, they have found their way into the risk
management options of just about every major financial institution.
Derivatives are used for the following:
 A hedge or mitigate risk in the underlying, by entering in to a
derivative contract whose value moves in the opposite direction to
their underlying position and cancels part or all of it out.
 Create option ability where the value of the derivative is linked to a
specific condition or event (e.g. the underlying rea ching a specific
price level)
 Obtain exposure to the underlying where it is not possible to trade
in the underlying.
 Provide leverage (or gearing), such that a small movement in the
underlying value can cause a large difference in the value of the
derivat ive.
 Speculate and make a profit if the value of the underlying asset
moves the way they expect (e.g. moves in a given direction, stays
in or out of a specified range, reaches a certain level)
 Switch asset allocations between different asset classes witho ut
disturbing the underlining assets, as part of transition management
 Avoid paying taxes. For example, an equity swap allows an
investor to receive steady payments, e.g. based on LIBOR rate
while avoiding paying capital gains tax and keeping the stock.
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106 7.2.2 Advantages of Derivatives:
1. They help in transferring risks from risk -averse people to risk -
oriented people.
2. They help in the discovery of future as well as current prices.
3. They catalyze entrepreneurial activity.
4. They increase the vo lume traded in markets because of the
participation of risk -averse people in greater numbers.
5. They increase savings and investment in the long run.
7.2.3 Types of Derivative:
In broad terms, there are two groups of derivative contracts, which are
distinguished by the way they are traded in the market:
1. Over -the-counter :
(OTC) derivatives are contracts that are traded (and privately negotiated)
directly between two parties, without going t hrough an exchange or other
intermediary. Products such as swaps , forward rate agreements , exotic
options – and other exotic derivatives – are almost always traded in this
way. The OTC derivative market is the largest market for derivatives, and
is largely unregulated with respect to the disclosure of inform ation
between the parties, since the OTC market is made up of banks and other
highly sophisticated parties, such as hedge funds . Reporting of OTC
amounts is difficult because trades can occur in private, without the
activity being visible on any exchange. According to the Bank for
International Settlements , who first surveyed OTC derivatives in 1995,
reported that the " gross market value , which represents the cost of
replacing all open contracts at the prevailing market prices, ... increased by
74% since 2004, to $11 trillion at the end of June 2007 (BIS 2007:2 4)."
Positions in the OTC derivatives market increased to $516 trillion at the
end of June 2007, 135% higher than the level recorded in 2004. the total
outstanding notional amount is US$708 trillion (as o f June 2011). Of this
total notional amount, 67% are interest rate contracts , 8% are credit
default swaps (CDS) , 9% are foreign exchange contract s, 2% are
commodity contracts, 1% are equity contracts, and 12% are other. Because
OTC derivatives are not traded on an exchange, there is no central
counter -party. Therefore, they are subject to counterparty ris k, like an
ordinary contract , since each counter -party relies on the other to perform.
2. Exchange -traded derivatives :
(ETD) are those derivati ves instruments that are traded via specialized
derivatives exchanges or other exchanges. A derivatives exchange is a
market where individuals trade standardized contracts that have been
defined by the exchange. A derivatives exchange acts as an intermediary
to all related transactions and takes initial margin from both sides of the
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107 the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex,
and CME Group .
For better conceptual understanding deri vatives and the most common
types of derivatives are classified as forwarding contracts, futures
contracts, options contracts, and swap contracts. These are the most
common use types of derivatives:
A. Forward Contracts :
A forward contract is an agreemen t between two parties – a buyer and a
seller to purchase or sell something at a later date at a price agreed upon
today. Forward contracts, sometimes called forward commitments, are
very common in everyone's life. Any type of contractual agreement that
calls for the future purchase of a good or service at a price agreed upon
today and without the right of cancellation is a forward contract.
B. Future Contracts:
Market in standardized contracts for future delivery of various goods. A
futures contract is a n agreement between two parties – a buyer and a seller
– to buy or sell something at a future date. The contact trades on a futures
exchange and is subject to a daily settlement procedure. Future contracts
evolved out of forwarding contracts and possess ma ny of the same
characteristics. Unlike forward contracts, futures contracts trade on
organized exchanges, called future markets. Future contacts also differ
from forwarding contacts in that they are subject to a daily settlement
procedure. In the daily set tlement, investors who incur losses pay them
every day to investors who make profits. It arose in the mid -1800s in
Chicago and institutionalized an ancient form of contracting called
forward contracts. In 1842, the Chicago Board of Trade was
founded.In1871 , Fire destroyed all records.
C. Options Contracts :
Options are contractual obligations that Derive their value from some
underlying asset. Options are of two types – calls and puts. Calls give the
buyer the right but not the obligation to buy a given qua ntity of the
underlying asset, at a given price on or before a given future date. Puts
give the buyer the right, but not the obligation to sell a given quantity of
the underlying asset at a given price on or before a given date. In options
on futures contr acts, the contractual obligations call for delivery of one
futures contract.
D. Binary contracts :
Binary contracts are contracts that provide the owner with an all -or-
nothing profit profile.
E. Warrant:
Apart from the commonly used short -dated options wh ich have a
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108 as well, known as the warrant. These are generally traded over -the-
counter.
F. Swaps :
Swaps are private agreements between two parties to exchange cash flows
in the futur e according to a prearranged formula. They can be regarded as
portfolios of forwarding contracts. The 1st major swap occurred in August
of 1981. The World Bank issued $290 million in Eurobonds and swapped
the interest and principal on these bonds with IBM for Swiss francs and
German marks. The two commonly used swaps are interest rate swaps and
currency swaps.
1. Interest rate swaps: These involve swapping only the interest -
related cash flows between the parties in the same currency.
2. Currency swaps: These entail swapping both principal and interest
between the parties, with the cash flows in one direction being in a
different currency than those in the opposite direction.
Forward Markets V/S Future Markets :
a. Forward Contract transaction in which two p arties agree in advance
on the terms of a trade to be executed later whereas a futures contract
is traded in an organized exchange.
b. Forward contracts are non -standardized contract terms whereas
future contracts are standardized contract terms
c. Forward contr acts are more flexible as compared to future contracts.
d. Forward contracts are difficult to find a trading partner but in the
case of futures contracts, the contract is guaranteed by the exchange.
7.2.4 Participants of Derivative Markets
The following are the participants in the derivatives market.
1. Hedgers:
They are cautious traders in stock markets. They enter derivative
markets to secure their investment portfolio against the market risk and
price movements. They can achieve this by taking an opposite po sition
in the derivatives market. In this manner, they transfer the risk of loss
to those others who are ready to take it. To have this benefit, they are
required to pay a premium to the risk -taker.
2. Speculators:
They are risk -takers of the derivative mar ket. They are ready to take
risks to earn profits. If their anticipation of price movements proves to
be correct, they can earn huge profits.
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109 3. Margin Traders:
A margin refers to the minimum amount that is required to be
deposited with the broker to parti cipate in the derivative market. It is
used to compensate for the losses if any, while trading in the
derivatives market.
4. Arbitrageurs:
They deal in low -risk, low -priced securities to make profits. They buy
low-priced securities in one market and sell t hem at a higher price in
another market. This can take place only when the same security is
quoted at different prices in different markets.
7.2.4 Commodity Markets
A commodity market is a market that trades in the primary economic
sector rather than manuf actured products, such as cocoa, fruit and sugar.
Hard commodities are mined, such as gold and oil. Futures contracts are
the oldest way of investing in commodities. Commodity markets can
include physical trading and derivatives trading using spot prices,
forwards, futures, and options on futures. Farmers have used a simple
form of derivative trading in the commodity market for centuries for price
risk management.
7.2.5 Categories of Commodity Markets
Commodities that are traded are typically sorted into fo ur categories broad
categories: metal, energy, livestock and meat, and agricultural.

Metals
Metals commodities include gold, silver, platinum, and copper. During
periods of market volatility or bear markets, some investors may decide to
invest in precious metals, particularly gold —because of its status as a
reliable, dependable metal with real, conveyable value. Investors may also
decide to invest in precious metals as a hedge against periods of high
inflation or currency devaluation.

Energy commodities
Energy commodities include crude oil, heating oil, natural gas, and
gasoline. Global economic developments and reduced oil outputs from
established oil wells around the world have historically led to rising oil
prices, as demand for energy -related products has gone up at the same
time that oil supplies have dwindled.

Energy
Investors who are interested in entering the commodities market in the
energy sector should also be aware of how economic downturns, any shifts
in production enforced by the Organizatio n of the Petroleum Exporting
Countries (OPEC), and new technological advances in alternative energy
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110 oil as a primary source of energy, can all have a huge impact on the
market pric es for commodities in the energy sector.

Livestock and meat
Livestock and meat commodities include lean hogs, pork bellies, live
cattle, and feeder cattle.

Agriculture
Agricultural commodities include corn, soybeans, wheat, rice, cocoa,
coffee, cotton, a nd sugar. In the agricultural sector, grains can be very
volatile during the summer months or during any period of weather -related
transitions. For investors interested in the agricultural sector, population
growth —combined with limited agricultural supply —can provide
opportunities for profiting from rising agricultural commodity prices.
7.3 START -UP VENTURES
Startup capital is what entrepreneurs use to pay for any or all of the
required expenses involved in creating a new business. This includes
paying f or the initial hires, obtaining office space, permits, licenses,
inventory, research and market testing, product manufacturing, marketing,
or any other expense. In many cases, more than one round of startup
capital investment is needed to get a new busines s off the ground.
The majority of startup capital is provided to young companies by
professional investors such as venture capitalists and/or angel investors.
Some startups may also receive startup capital from banks and other
financial institutions. Consi dering the sources of startup capital, it's no
surprise that companies may receive large amounts of money from their
investors. Since investing in young companies comes with a great degree
of risk, these investors often require a solid business plan in exc hange for
their money. They usually get an equity stake in the company for their
investment.
7.3.1 Sources of start -up financing
It is always better to use different sources for financing the new business
besides a bank loan. The following are typical sou rces of financing start -
ups.
1. Personal Investment:
While starting a new business an entrepreneur should have his savings
and/or assets as collateral security for investing in the business.
2. Love money:
This is the money that an entrepreneur borrows from a spouse, parents,
family, or friends. He should be cautious while borrowing love money
as they may like to have an equity stake in the business.
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111 3. Venture Capital:
Every entrepreneur cannot depend upon venture capital. Because
generally venture capitalis ts are very selective in their approach and
they prefer to invest in technology -driven businesses and companies
with high growth potential in sectors such as information technology,
communications, and biotechnology Venture capitalists also require to
be given some ownership or equity stake in the business.
4. Angels:
Angels are generally wealthy individuals or retired company
executives who invest directly in small firms owned by others. They
also contribute to the business by way of their expertise, experi ence,
and/or managerial knowledge.
5. Business incubators:
Business incubators provide various services for new businesses such
as sharing their premises and even laboratories as well as their
administrative logistical and technical resources. Generally, th e
incubation phase lasts up to two years. Once the product is ready, an
entrepreneur leaves the incubator’s premises and starts its industrial
production phase. Such services are available in sectors such as
biotechnology, information technology, multimedi a, or industrial
technology.
6. Government Grants and Subsidies:
Government agencies finance venture capital in the form of grants and
subsidies. An entrepreneur needs to go through a long and complicated
procedure to avail of grants and subsidies. He has t o submit a detailed
project report giving details like project description, the significance of
the project, cost structure, resources available, projected return on
investment, and so on.
7. Bank Loans:
A bank loan is the major source of financing venture capital for small
and medium -sized businesses. An entrepreneur needs to select the
bank that meets his specific needs. He has to fulfill various
requirements for getting bank loans such as a detailed project report
and the guarantee.
Check Your Progress
1. Fill in the blanks:
a. Agreement between two to purchase or sell something at a later date
at a price agreed upon today means ---------- .
b. --------------- are non -standardized contract terms.
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112 d. The two comm only used swaps are ---------------- and ----------------- .
2. “Angel Investor” Discuss.
3. Explain the types of Options – calls and puts.
7.4 MICRO -FINANCE
Microfinance is a general term to describe financial services to low -
income individuals or to tho se who do not have access to typical banking
services. Microfinance is also the idea that individuals are capable of
lifting themselves out of poverty if given access to some of the financial
services. The two main mechanisms for the delivery of financial services
to such clients are:
 Relationship -based banking for individuals entrepreneurs and small
business; and
 Group -based models, where several individual entrepreneurs come
together to apply for loans and other services as a group.
"Microfinance is the supply of loans, savings, and other basic financial
services to the poor." As these financial services usually involve small
amounts of money - small loans, small savings, etc. - the term
"microfinance" helps to differentiate these services from those whi ch
formal banks provide.
7.4.1 FEATURES OF MICROFINANCE
1) It is an essential part of rural finance.
2) It deals in small loans.
3) It caters to poor households.
4) It is one of the most effective and warranted Poverty
Alleviation Strategies.
5) It support s women's participation in the electronic activity.
6) It provides an incentive to grab self-employment opportunities.
7) It is more service -oriented and less profit -oriented.
8) It is meant to assist small entrepreneurs and producers.
9) Poor borrowers ar e rarely defaulters in repayment of loans as they
are simple and God -fearing.
10) India needs to establish several Microfinance Institutions.
7.4.2 Importance Of Microfinance: -
Microfinance institutions are those which provide credit and other
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113 semi -urban, and urban areas for enabling them to raise their income and
improve their standard of living.
1. Credit to Rural Poor:
Usually, the rural sector depends on non -institutional age ncies for their
financial requirements. Microfinancing has been successful in taking
institutionalized credit to the doorstep of the poor and has made them
economically and socially sound.
2. Poverty Alleviation:
Due to microfinance poor people get emplo yment. It also helps them to
improve their entrepreneurial skills and encourages them to
exploit business opportunities. Employment increases income level which
in turn reduces poverty.
3. Women Empowerment:
Normally more than 50% of SHGs are formed by women. Now they have
greater access to financial and economical resources. It is a step towards
greater security for women. Thus microfinance empowers poor women
economically and socially.
4. Economic Growth:
Finance plays a key role in stimulating sus tainable economic growth. Due
to microfinance, the production of goods and services increases which
increase GDP and contribute to the economic growth of the country.
5. Mobilisation of Savings:
Microfinance develops saving habits among people. Now poor p eople
with meager income can also save and are bankable. The financial
resources generated through savings and microcredit obtained from banks
are utilized to provide loans and advances to its members. Thus
microfinance helps in the mobilization of savings .
6. Development of Skills:
Microfinancing has been a boon to potential rural entrepreneurs. SHGs
encourage its members to set up business units jointly or individually.
They receive training from supporting institutions and learn leadership
qualities. Thu s microfinance is indirectly responsible for the development
of skills.
7. Mutual Help and Co -operation:
Microfinance promotes mutual help and cooperation among members. The
collective efforts of the group promote economic interest and help in
achieving so cio-economic transition.
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114 8. Social Welfare:
With employment generation the level of income of people increases.
They may go for better education, health, family welfare, etc. Thus
microfinance leads to social welfare or betterment of society.
7.4.3 Microf inance Institutions:
A microfinance institution (MFI) is an organization that provides
microfinance services. MFIs range from small non -profit organizations to
large commercial banks. In the 1990s, many of these institutions
transformed themselves into fo rmal financial institutions to access and on -
lend client savings, thus enhancing their outreach.
7.4.4 Profitability and Sustainability of MFIs :
Some worry that an excessive concern for profit in microfinance will lead
MFIs away from poor clients to serve better -off clients who want larger
loans. Programs serving very poor clients are indeed somewhat less
profitable than those reaching better -off clients, but this may say more
about managers' objectives than an inherent conflict between serving the
very poo r and profitability. Microfinance programs like Bangladesh Rural
Advancement Committee and ASA in Bangladesh have already
demonstrated that very poor clients can be reached profitably both
institutions had profits of more than 4% of assets in 2000."There a re cases
where microfinance cannot be made profitable, for example, where
potential clients are extremely poor and risk -averse or live in remote areas
with very low population density. In such settings, microfinance may
require continuing subsidies. Whethe r microfinance is the best use of these
subsidies will depend on evidence about its impact on the lives of this
client
7.4.5 Role of Self Help Group and Functions Of Micro Finance
Programs:
Microfinance programs have generally targeted poor women. By
providing access to financial services only through women -making
women responsible for loans, ensuring repayment through women,
maintaining savings accounts for women, providing insurance coverage
through women -microfinance programs send a strong message to
households as well as to communities.
1. Poverty reduction tools:
Microfinance can be a critical element of an effective poverty reduction
strategy. Improved access and efficient provision of savings, credit, and
insurance facilities, in particular, can en able the poor to smooth their
consumption, manage their risks better, build their assets gradually, and
develop their microenterprises. Microfinance is only a means and not an
end. The ultimate goal is to reduce poverty.
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115 2. Self Employment:
Poverty reduc tion through self -employment has long been a high priority
for the Government of India. Microfinance is an experimental tool in its
overall strategies. Most poor people manage to optimize resources over
time to develop their enterprises. Financial services could enable the poor
to leverage their initiative, accelerating the process of generating incomes,
assets, and economic security.
3. SHG -bank linkage program:
Indian microfinance is dominated by the operational approach of Self -help
Groups (SHGs). The approach is popularly known as the SHG -Bank
linkage model. This model is the dominant model, initiated by the
NABARD in the early 1990s. Today the SHG model also links the
informal groups of women to the mainstream system and it has the largest
outreach to micro -financial clients in the world. SHGS comprise a group
of 15 -20 members.
In India, more than 70% of the population lives in villages and most of
these villages are underdeveloped. The government, NGOs, and other
financial institutions have introduce d various welfare schemes and
activities to reduce poverty.
7.4.6 Types of MF Providers:
The different legal forms under which MF can be provided in India are:
1. Commercial Banks
2. Cooperative Banks
3. Regional Rural Banks (RRBs)
4. Local Area Banks (LABs)
5. Cooperative Societies, SHGs, and Federation
6. Societies
7. Trusts
8. Sec 25 (Not for Profit) company
9. Non-Banking Finance Companies (NBFCs)
10. Organisations under Business
7.5 SELF HELP GROUPS ( SHG )
Self Help Groups generally operate in rural India. They are also found in
other countries, especially in South Asia and Southeast Asia. It generally
consists of 10 -20 self -employed rural women. Members of the group are
encouraged to serve a small amount regularly and contribute to the
common fund. After few months, when a sizable amount is accumulated
the group starts lendi ng back to the members as to others in the village for
some purpose. In India, many SHGs are linked to banks for the delivery of
microcredit. Microcredit refers to small loans that help poor rural women munotes.in

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116 to meet their immediate credit needs. Central and Sta te Government along
with the National Bank for Agriculture and Rural Development are
encouraging Self Help Groups to achieve women empowerment.
7.5.1 Role of Self Help Groups
The role of SHGS in India can be given with the help of the following
points -
 Initiate and maintain savings within the group:
All members must regularly save at least a small amount. These
savings allow them to get future credits for their group .
 Lending loans to the members:
The savings made by the SHG must be used to provide loan s to
members of the group. Everything related to the loan must be decided
within the group.
 Solving common problems:
SHGs mostly consist of individuals who face similar problems. The
grouping should essentially help the individual overcome these
problems through discussions and interactions within the group and
overcoming the problems and finding a common and united solution
to the problems.
 Bank Loans:
SHGs work on getting a collective guarantee system so that they can
avail of loans from official source s.
Thus they are of great help to achieve sustainable economic development
in India.
 Poverty Alleviation:
The formation of SHGs has helped the members save a part of their
income. It has increased its assets, income, and generated employment
opportunities . There has been a significant shift in the use of loans for
personal use to them being used for income generation. The cumulative
savings of the members had made them financially stable. This has helped
them come out of the vicious circle of poverty and un employment.
 Financial Inclusion:
According to the NSSO survey(59th round), more than half of the farmer
households in rural India do not have access to formal credit. Overall
around 70% of all the households don't have any access to institutional
credit. M icrofinance helps the SHGs access formal institutions like the
banks both for saving and securing loans. The members of the SHGs are
thus able to minimize their dependence on money lenders. Thus, SHGs
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117  Human Resource Development:
The financial stability of the members encourages them to spend more on
the education of their children. The member households have reported
better school attendance and a decrease in school dropout rates. The
financia l stability has led to lower child mortality, improved maternal
health, good nutrition, housing, and health – especially among women and
children.
 Women Empowerment:
The contribution of women to household income has increased. It gave
them better control o ver the decisions that affect their lives. It has led to an
increased involvement of women in decision making. It has increased their
awareness about various welfare schemes and organizations and access to
such organizations. The Expenditure on girl educa tion in member
households has also increased.
7.6 SUMMARY
A lease is a contract calling for the lessee (user) to pay the lessor (owner)
for use of an asset. A rental agreement is a lease in which the asset is
tangible property. Leases for the intangible pr operty could include the use
of a computer program or the use of a radio frequency.
Mutual funds raise money by selling shares of the fund to the public and
use it to purchase various investment vehicles, such as stocks , bonds ,
and money market instrume nts. In return for the money they give to the
fund when purchasing shares, shareholders receive an equity position in
the fund and, in effect , in each of its underlying securities . For m ost
mutual funds, shareholders are free to sell their shares at any time.
Benefits of mutual funds include diversification and professional money
management . Mutual funds offer choice, liquidity , and convenience, but
charge fees and often require a minimum investment . Every Mutual Fund /
launches different schemes, each with a specific objective
The derivative itself is merely a contract between two or more parties. Its
value is determined by fluctuations in the underlying asset. The most
common underlying assets include stocks, bonds, commodities,
currencies, interest rates, and market indexes. There are two kinds of
derivative instruments – futures and options. Futures contracts, forward
contracts, options, and swaps are the most common types of derivatives.
Venture capital is the term for money invested in young, fast -growing
companies. Venture capital is provided as seed funding to early -stage,
high-potential, and growth companies. To put it simply, an investment
firm will give money to a growing company. The growing company will
then use this money to advertise, do research, build infrastructure, develop
products, etc. The investment firm is called a venture capital firm, and the
money that it gives is called venture capital. Venture Capital is a form of
“risk capital”. In other words, capital is invested in a project where there is
a substantial element of risk r elating to the future creation of profits and munotes.in

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118 cash flows. Risk capital is invested as shares rather than as a loan and the
investor requires a higher “rate of return” to compensate him for his risk.
Venture capital provides long -term, committed share capit al, to help
unquoted companies grow and succeed.
7.7 EXERCISE
Multiple Choice Questions
1. The person who lets the asset be used by another person is called the
_____________
a) Lessor b) Lessee c) Broker d) Investor
2. person who utilizes the asset is called the _____________
a) Lessor b) Lessee c) Broker d) Investor
3. Long -term, non -cancellable lease contracts are known as ________
a) Financial Lease b) Operating Lease c) Direct Lease d) Leverage
Leasing
4. ________________ lease agreement give s to the lessee only a limited
right to use the asset
a) Financial Lease b ) Operating Lease c) Direct Lease d) Leverage
Leasing
5. Under ___________ arrangement, the assets are not physically
exchanged but it all happens in records only
a) Financial Le ase b ) Operating Lease c) Sale and Leaseback d) Leverage Leasing
6. Under _____________ arrangement, a third party is involved besides
lessor and lessee
a) Financial Lease b ) Operating Lease c) Sale and Leaseback d) Leverage Leasing
7. Under direct leasing, a firm acquires the right to use an asset from the
manufacturer directly
a) Financial Lease b ) Operating Lease c) Sale and Leaseback d) Direct Leasing
8. ____________ mutual fu nds must be willing to buy back their shares
from their investors at the end of every business day
a) Open Ended b) Close Ended c) SIP d) UTI
9. ________________ funds generally issue shares to the public only once,
when they are created through an initi al public offering
a) Open Ended b) Close Ended c) SIP d) UTI
10. _____________ is only a scheme that helps the investor to invest
regularly in mutual fund schemes.
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119 11. ________funds cater to both the investment needs of the p rospective
investors - namely fixed income as well as growth orientation.
a) Hybrid b) Open Ended c) Close Ended d) Any ended
12. Derivatives markets are markets that are based upon another market,
which is known as the ___________ market.
a) Underlyin g b) Overlying c) Worthlying d) None of the above
13. A ____________ i s an agreement between two parties – a buyer and a
seller to purchase or sell something at a later date at a price agreed
upon today.
a) Forward Contract b) Purchase Contract c) se lling contract
d) None of the above
14. Call and Put are types of ________ contracts
a) Forward b) Future c) Options d) Swaps
15. _____are private agreements between two parties to exchange cash
flows in the fu ture according to a prearranged formula.
a) Forward b) Future c) Options d) Swaps
Theory Questions
1. Explain the types of leasing.
2. Explain the Advantages and Limitations of Mutual Funds
3. Explain the Sources of start -up financing.
4. Define venture capital and state its advantages for a company
a. Define Micro Finance and Elaborate the role and functions of
Micro Finance.
b. What is Derivative Market? Explain in detail the types of
Derivative Market.
5. Write short notes:
a. Factors responsible for the growth of mutual funds
b. Systematic Investment Plan
c. Commodity Market
d. Participants in Derivatives Market
e. Types of Derivative Instruments
f. Role of Self Help Groups
g. Leasing
h. Financial Lease
i. Operating Lease
j. Derivative Market
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120 6. Explain the terms
a. Mutual Funds
b. SIP
c. Commodity Marke t
d. Hedgers
e. Speculators
f. Arbitrageurs
g. Forward Contracts
h. Future Contracts
i. Swaps
j. SHGs

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